It is useful to relate elasticity values to the policy question of the impact of higher or lower taxes on government tax revenue. Consider a situation in which a tax is already in place and the government considers increasing the rate of tax. Can an understanding of elasticities inform us on the likely outcome? The answer is yes. Suppose that at the initial tax inclusive price demand is inelastic. We know immediately that a tax rate increase that increases the price must increase total expenditure. Hence the outcome is that the government will get a higher share of an increased total expenditure. In contrast, if demand is elastic at the initial tax-inclusive price a tax rate increase that leads to a higher price will decrease total expenditure. In this case the government will get a larger share of a smaller pie – not as valuable from a tax revenue standpoint as a larger share of a larger pie.
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