Final answer:
The government can effectively raise tax revenue by taxing goods that generate negative externalities, such as tobacco, which corrects for market inefficiencies and discourages harmful behavior. However, taxing goods with highly elastic demand or supply may not significantly increase revenue, as it can lead to large decreases in the quantity demanded or supplied.
Step-by-step explanation:
The government can raise tax revenue and increase total economic surplus by taxing goods that generate negative externalities. This is because taxing such goods can correct market outcomes that would otherwise be inefficient due to the external costs not being considered in the market price. For example, a sin tax on tobacco not only generates revenue but also discourages smoking, aligning private costs more closely with social costs.
On the other hand, taxing goods with highly elastic demand may not significantly increase tax revenue because consumers can easily reduce their quantity demanded in response to the tax, thus reducing the overall tax collected. Similarly, taxing goods with highly elastic supply may not lead to substantial revenue, as producers can also easily reduce the quantity supplied. While the imposition of a tax creates a wedge between the price paid by consumers (Pc) and the price received by producers (Pp), the tax incidence depends on the relative elasticities of supply and demand. In markets with inelastic supply and elastic demand, producers bear a larger tax burden than consumers, and vice versa.
Overall, to raise revenue without harming public policy goals, governments should aim to tax goods that have less elastic supply and demand or those that generate negative externalities, as this typically results in less distortionary effects and higher revenue generation.