Shifting and incidence of taxation involve determining the economic entity that actually bears the burden of a tax. While a tax might legally be levied on a particular entity, the economic incidence captures who ultimately pays it. This distinction is crucial in evaluating the effectiveness and fairness of various tax policies.
Definition and Basic Concepts
- Tax incidence refers to the analysis of the effect of a particular tax on the distribution of economic welfare. Identifying the incidence means understanding who bears the true cost of the tax — the producer, consumer, shareholders, or employees.
- Shifting of tax involves the process by which the tax burden is transferred from the entity legally responsible for paying it to another entity.
Types of Taxes and Their Incidence
-
Sales Tax:
- Legal Incidence: Retailer
- Economic Incidence: Generally passed onto consumers in the form of higher prices.
-
Corporate Income Tax:
- Legal Incidence: Corporation
- Economic Incidence: Can fall on shareholders (lower dividends), employees (lower wages), or consumers (higher prices), but typically not fully passed on.
Theories of Tax Incidence
- Statutory Incidence: The legal responsibility to pay the tax.
- Economic Incidence: The actual economic burden of the tax after market adjustments.
Factors Influencing Tax Incidence
Elasticity
- Price Elasticity of Demand: If demand is inelastic, consumers are more likely to bear the tax burden.
- Price Elasticity of Supply: If supply is inelastic, producers are more likely to bear the tax burden.
Market Structure
- Competitive Markets: Taxes are mostly passed on to consumers due to competitive pricing.
- Monopolistic Markets: The monopolistic entity might absorb more of the tax because of pricing power.
Examples and Applications
Sales Tax and Consumer Pricing
When a government imposes a sales tax, the retailer generally increases the price of goods to compensate for the additional tax burden. For example, if a product costs $100 and the sales tax is 10%, the final price to the consumer becomes $110.
Corporate Income Tax and Profit Distribution
A corporation facing a higher corporate income tax might respond by reducing dividends to shareholders, lowering wages or benefits to employees, or slightly increasing prices of products if market conditions allow.
Historical Context
Evolution of Tax Policies
Historically, the approaches and philosophies surrounding taxation and its incidence have evolved. Early economic theories in the 18th and 19th centuries started to consider the broader impacts of taxes beyond the immediate payer.
Comparisons and Related Terms
- Direct Tax: Paid directly by an individual or organization (e.g., income tax).
- Indirect Tax: Collected by an intermediary (e.g., sales tax).
Economic Impact
- Regressive Tax: Imposes a higher burden on lower-income individuals relative to their income.
- Progressive Tax: Imposes a higher burden on higher-income individuals relative to their income.
FAQs
What is the difference between statutory and economic incidence of tax?
Can a corporation fully pass on its taxes to consumers?
References
- Musgrave, R.A., & Musgrave, P.B. (1989). Public Finance in Theory and Practice. McGraw-Hill.
- Fullerton, D. (1982). “On the Possibility of an Inverse Relationship between Tax Rates and Government Revenues”. Journal of Public Economics, 19(1): 3–22.
Summary
Understanding the shifting and incidence of taxation helps in evaluating the real burden of taxes beyond their nominal assignment. The allocation of tax burdens affects economic equity and efficiency, influencing policy decisions and market behavior. Recognizing the complexities in the incidence of taxes can lead to more informed and equitable fiscal policies.
