The Revenue from an Excise Tax

How much revenue does the government collect from an excise tax? In our hotel tax example, the revenue is equal to the area of the shaded rectangle in Figure 7-6.

The Revenue from an Excise Tax The revenue from a $40 excise tax on hotel rooms is $200,000, equal to the tax rate, $40—the size of the wedge that the tax drives between the supply price and the demand price—multiplied by the number of rooms rented, 5,000. This is equal to the area of the shaded rectangle.

To see why this area represents the revenue collected by a $40 tax on hotel rooms, notice that the height of the rectangle is $40, equal to the tax per room. It is also, as we’ve seen, the size of the wedge that the tax drives between the supply price (the price received by producers) and the demand price (the price paid by consumers). Meanwhile, the width of the rectangle is 5,000 rooms, equal to the equilibrium quantity of rooms given the $40 tax. With that information, we can make the following calculations.

The tax revenue collected is:

Tax revenue = $40 per room × 5,000 rooms = $200,000

The area of the shaded rectangle is:

Area = Height × Width = $40 per room × 5,000 rooms = $200,000

or

Tax revenue = Area of shaded rectangle

This is a general principle: The revenue collected by an excise tax is equal to the area of the rectangle whose height is the tax wedge between the supply and demand curves and whose width is the quantity transacted under the tax.