Excise Taxes and the Stability of Price Elasticity Ralph C. Gamble Fort Hays State University Rory Terry Fort Hays State University Dosse Toulaboe Fort Hays State University

When demand is linear, and supply is perfectly elastic, tax revenue is maximized at a per-unit tax that causes demand elasticity to increase to twice its initial value, plus one. This is termed the 2+1 rule. This paper shows that the 2+1 rule also applies to classes of nonlinear demand functions, thus justifying the assumption of demand-function linearity for tax-revenue maximization in these cases. We also demonstrate that while optimal tax revenue and price elasticity of demand are inversely related, it is not necessarily best from a tax-revenue maximization perspective to tax the lower elasticity good. INTRODUCTION For economics principles classes, excise taxes provide plentiful current-events linkages to topics such as elasticity of demand and supply, deadweight welfare loss, consumer and producer surplus, tax burden, tax efficiency, and trade. But the lessons illustrated are often more complex than they appear at first glance. In this paper, “elasticity” (denoted by ε) will always mean “price elasticity”, will always be positive, and will range from 0 to ∞. We will use the following notation in referring to price elasticity of demand: ε = 0: “Perfectly inelastic” 0< ε