What Is a Tax Incidence?

The term tax incidence refers to the legal and economic burden of taxation. From a legal standpoint, it refers to who is responsible for paying the tax regardless of who remits it to the government. On an economic level, it can also be related to the price elasticity of supply and demand.&n🔯bsp;When supply is more elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of the tax.

How a Tax Incidence Works

The tax incidence depicts the distribution of tax obligations, which must be covered by the buyer and seller. The level at which each party participates in covering the obligation shifts based on the associated price elasticity of the product or service in question as well as how the product or service is currently affected by the principles of 澳洲幸运5官方开奖结果体彩网:supply and demand.

Tax incidence also reveals which group (consumers or producers) pays the price of a new tax. For example, the demand for prescription drugs is relatively 澳洲幸运5官方开奖结果体彩网:inelastic. That means that despite cha🦩nges in𝄹 cost, its market remains relatively constant.

Le✤vying New Taxes on Inelastic and Elastic Goods

The demand for cigarettes is mostly inelastic. When governments impose a cigarette tax, producers increase the sale price by the full amount of the tax, transferring the tax burden to consumers. Through analysis, it's been found that the demand for cigarettes is unaffected by price. Of course, there are limits to this theory. If a pack of cigarettes suddenly increased from $5 to $1,000, consumer demand would fall.

If the levying of new taxes on an elastic good, such ꦚas fine jewelry, occurs, most of the burden would likely shift to the producer as an increase in price may have a significant impact on the demand for the associated goods. Elastic goods are goods that have close substitutes or that are nonessential.

Tax Incidence and Price Elasticity

Price elasticity represents how buyer activity changes in response to movements in the price of a good or service. When the buyer is likely to continue purchasing a good or service regardless of a price change, the demand is said to be inelastic. When the price of the product or service profoundly impacts the level of demand, the demand is considered highly elastic.

Examples of inelastic goods or services can include gasoline and prescription medicines. The level of consumption across the economy remains steady with price changes. Elastic products are those whose demand is significantly affected by price. This group of products includes luxury goods, houses, and clothing.

The formula for determining the consumer's tax burden, with "E" representing elasticity, is as follows:

Consumer Tax Burden = E (supply) ÷ [E (demand)) + E (supply)]

The formula for determining the producer or supplier's tax burden, with "E" representing elasticity, is as follows:

Producer Tax Burden = E (demand) ÷ [E (demand) + E (supply)]

The Bottom Line

Tax incidence can determine the fairness of a taxation system by contrasting the tax burden across a population. It can also measure the burden between producers and consumers. Elasticity, which measures the relationship between prices and the demand for goods, ꦆhelps determine tax incidence. Inelastic goods are thosꦓe that consumers will continue to buy, even as the price goes up like gasoline and prescription drugs. By contrast, consumer demand drops as prices rise for elastic goods like a new home or cars. The tax burden shifts with inelastic versus elastic goods.