Suppose the government increases the size of a tax by 20 percent. The deadweight loss from that tax:

• A. increases by less than 20 percent
• B. increases by exactly 20 percent
• C. remains unchanged
• D. increases by more than 20 percent

Answer: (D)

Verified step by step guidance

1. Recall the formula for deadweight loss (DWL) from a tax, which is generally proportional to the square of the tax rate. Mathematically, DWL \( \propto t^2 \), where \( t \) is the tax rate.
2. Understand that if the tax rate increases by 20%, the new tax rate becomes \( t_{new} = 1.2 \times t \).
3. Substitute the new tax rate into the deadweight loss relationship: \( DWL_{new} \propto (1.2 \times t)^2 = 1.44 \times t^2 \).
4. Compare the new deadweight loss to the original: the deadweight loss increases by a factor of 1.44, which is a 44% increase, greater than the 20% increase in the tax rate.
5. Conclude that because deadweight loss increases with the square of the tax rate, a 20% increase in the tax rate leads to a more than 20% increase in deadweight loss.