Tax Incidence

Tax Incidence Definition:

Tax incidence in economics is defined as the shift of tax burden between the retailers and consumers. In other words tax incidence is nothing but the change in supply and demand. Tax incidence basically applies to that part where a goods price is the deciding factor of levying a tax. It means when the supply is less than demand, tax burden falls on the buyers and when the supply is more than demand, producers will bear the tax burden.

Types of tax incidence

The statutory incidence of tax refers to the payment of money to individuals in the form of salary or profits only on the terms that the amount is remitted to the government in the form of a tax.
The economic incidence of refers to the economic impact of taxation by government on the real income of the individuals.

Economic vs Statutory incidence

Economic incidence refers to the person or a group who actually bear the tax. Legislative incidence refers to the individual or a group who are responsible for physically remitting the tax to the government.

For example, statutory incidence means the income tax which is levied equally to employees and the employers by the government.  Economic incidence on the contrary refers to that part of the people who suffer from the higher taxes levied by the government on the middle and the lower income class or consumers with higher prices of commodities or shareholders with lower returns on their investment.

Estimating and Measuring tax incidence

Estimation of tax incidence generally involves a basic study into tax policy.

Generally tax incidence is estimated by assuming a market structure, wherein supply and demand variations are taken into consideration. Then studying the tax incidence or to which group the tax is shifted.

Example of measuring tax incidence

If an example is taken as to the sale of mangoes; if Rs.1 tax is levied on every 1000kg bag of mangoes a farmer produces, and if the mangoes price is inelastic then the farmer will shift the extra money which he pays in terms of tax to the consumers of the product (mangoes). It means that the consumer of the product is bearing the entire tax burden of the product.  But on the other hand, if the product’s price is inelastic, i.e. if the demand will be lost for a penny increase in the price of the product, then the farmer pays the tax instead of shifting the tax burden to the consumers. From this example it can be concluded that the tax incidence falls upon that individual or group who respond least to price. The main theme is tax incidence does not depend on where the money is made or collected but on the price elasticity of demand and price elasticity of supply.

In the above example, if the tax incidence falls on the farmer, then the people who get affected with are the owners of the product, the agricultural land including the farmer’s wages. Because, if the tax is paid by the farmer then the owner of the product is the one who has to pay the money as tax and this reduces the wages which the farmer has to get. The tax is passed onto the employee in the form of lower wages.

Tax incidence on wages

The average state corporate tax rate is 4.4%. it was found in the study that states with comparatively low corporate taxes have seen an increase in wages. Specifically a 1% drop in averagetax rate leads to a .014% increase in wages. In dollar terms, wages raise $2.50 for every $1 decrease in state local corporate taxes. Also a 1% hike in averagetax rate leads to a .014% decrease in wages.

Finally, the burden of these taxes is bared by the individuals who depend on the corporations.