Loss of Welfare

What is Loss of Welfare?

The loss of welfare is an economic variable. Companies have to accept a loss of welfare if, due to market disruptions, they can no longer produce the amount of goods that would be possible without these market disruptions. Private households are affected by the welfare loss if the disposable income decreases due to a market disruption. Monopoly and intervention by the state through tax increases come into consideration as market disruptions.

In this section we introduce you to the economic topic of loss of welfare. You will find out what the loss of welfare is and what significance the consumer surplus and the producer surplus have. We explain to you which market disturbances cause a loss of welfare. Finally, we will inform you about the tax wedge and the connection between the Harberger triangle and the loss of welfare. To deepen your knowledge, you can answer a few exercise questions after the article.

  • English: welfare loss
  • Synonyms: deadweight loss | Allocation loss

What Should You Know About Welfare Loss?

Manufacturing companies align the manufacturing process with the highest possible output. The output volume should be sold at a price that brings the company a profit. The national economy describes the difference between the profit and the cost of the product as producer surplus. In addition, one knows the consumer surplus in economics. This arises for a consumer when he has to pay less for a product than he would have been willing to pay.

Market disruptions cause producer surplus and consumer surplus to decrease. This means that both producers and consumers suffer a loss of welfare.

Which market disturbances cause the loss of welfare?

According to dictionaryforall.com, loss of welfare can be caused by the following market disruptions:

  • monopoly
  • steer

Loss of welfare with monopoly

With the market form of the monopoly, all companies – with the exception of the monopoly himself – suffer a loss of welfare. If the monopolist uses his unique selling point by increasing the prices for his products, he will achieve a higher consumer surplus. In contrast, the consumer surplus of the other companies is falling. They suffer a loss of welfare.

Loss of welfare through taxes

In addition, a loss of welfare in an economy can also be brought about by intervention by the state. If this z. B. VAT, only private consumers are affected by the loss of welfare, since they are liable for VAT.

Loss of welfare: graphic representation of the Harberger triangle

Companies are not exempt from paying sales tax. However, since they are entitled to input tax deduction, they can have the sales tax paid as input tax reimbursed using the monthly sales tax return.

Companies subject to trade tax have to suffer a loss of welfare if they choose a region for the location of their business in which they have to pay a higher amount of trade tax. This is because the municipalities are responsible for administering trade tax. This means that the trade tax rate is set by the respective council of the municipality or city. If the company moves from a municipality with a low trade tax rate (e.g. 200%) to the area of ​​a city that has set its trade tax multiplier at 300%, it must record a welfare loss. This is only justifiable if the company can derive other advantages from the location.

Loss of Welfare

Example: sales tax

A brewery purchases hops and malt from various suppliers to produce a new type of beer. The brewery can have the tax office reimbursed the VAT amounts shown in the invoices as input taxes. In this case, the intervention of the state – e.g. B. by increasing the VAT rate – not a loss of welfare for companies.

Example: trade tax

A GmbH moves from city X to city Y. The managing director expects the move to give himself a competitive advantage because he sees better sales opportunities for the products in city Y. Because the trade tax multiplier of city Y is higher than that of city X, the GmbH has to accept a loss of welfare here.

What does control wedge mean?

The term control wedge can be used in several contexts. If the state increases z. B. the VAT rate from the current 19% to 20%, this has a direct impact on the market. The companies offer their products at a higher gross sales price. This discourages some consumers from buying. As a result, there are shifts in the supply function and the demand function. The economy calls the difference a tax wedge because it is based solely on the increase in VAT.

In addition, the term tax wedge is also known in wage tax law. It describes the difference between the total costs that an employer incurs for an employee and his or her net earnings. However, wage tax does not play a role here, as it is borne exclusively by the employee. The tax wedge is made up of the employer’s social security contributions for the employee.

What is the connection between the Harberg triangle and the loss of welfare?

The Harberger triangle is used to measure the proportion of a loss of welfare that can be traced back to a tax increase. The Harberger triangle was first used by the financial scientist Arnold Harberger.