Tax Wedge


DEFINITION of 'Tax Wedge'

1. The difference between before-tax and after-tax wages. The tax wedge measures how much the government receives as a result of taxing the labor force.

2. A measure of the market inefficiency that is created when a tax is imposed on a product or service. The tax causes the supply and demand equilibrium to shift, creating a wedge of dead weight losses.


1. The tax wedge is the difference between what employees take home in earnings and what it costs to employ them, or the dollar measure of the income tax rate. In some countries, the tax wedge increases as employee income increases. This reduces the marginal benefit of working therefore employees will often work less hours than they would if no tax was imposed. Some argue that the tax wedge on investment income will also reduce savings, create less innovation, and ultimately lowers living standards.

2. By having a tax wedge the inefficiency will cause the consumer to pay more and the producer to receive less. This is due to higher equilibrium prices paid by consumers and lower equilibrium quantities sold by producers.

  1. Equilibrium

    The state in which market supply and demand balance each other ...
  2. Supply

    A fundamental economic concept that describes the total amount ...
  3. Marginal Utility

    The additional satisfaction a consumer gains from consuming one ...
  4. Income Tax

    A tax that governments impose on financial income generated by ...
  5. Deadweight Loss

    The costs to society created by market inefficiency. Mainly used ...
  6. Demand

    An economic principle that describes a consumer's desire and ...
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