Economists have devoted considerable effort to studying the effects of taxes. In particular, they study how taxes affect people’s behavior, including their choices in working, saving, and investing.
To understand the effect of any tax, one must first determine who bears the burden of the tax. This is not always an easy task. Suppose that the price of a chocolate doughnut is $1.00. The government then imposes on sellers a tax of 10 cents per doughnut. A few weeks after its imposition, the tax causes the price to increase to $1.10. The doughnut seller clearly receives the same amount per doughnut as he or she did before the tax—the tax has not made the seller worse off. Consumers pay the entire tax in the form of higher prices. On the other hand, suppose that after the tax the price increases to $1.04. In this case, the seller keeps only 94 cents per doughnut, and is worse off by 6 cents per doughnut. Consumers are also worse off, however, because they have to pay 4 cents more per doughnut. In this case, retailers and consumers share the burden of the tax.
The way a tax affects people is called the tax incidence. The statutory incidence of a tax refers to the individuals or groups who must legally pay the tax. The statutory incidence reveals essentially nothing about a tax’s real burden, because as previously illustrated, prices may change in response to a tax. In contrast, the economic incidence of a tax refers to its actual effects on people’s incomes. The economic incidence of a tax depends on how buyers and sellers of the commodity react when the tax is imposed. The more sensitive consumers are to changes in price, the easier it is for them to turn to other products when the price goes up, in which case producers bear more of the tax burden. On the other hand, if consumers purchase the same amount regardless of price, they bear the whole burden.
To understand the effect of any tax, one must first determine who bears the burden of the tax. This is not always an easy task. Suppose that the price of a chocolate doughnut is $1.00. The government then imposes on sellers a tax of 10 cents per doughnut. A few weeks after its imposition, the tax causes the price to increase to $1.10. The doughnut seller clearly receives the same amount per doughnut as he or she did before the tax—the tax has not made the seller worse off. Consumers pay the entire tax in the form of higher prices. On the other hand, suppose that after the tax the price increases to $1.04. In this case, the seller keeps only 94 cents per doughnut, and is worse off by 6 cents per doughnut. Consumers are also worse off, however, because they have to pay 4 cents more per doughnut. In this case, retailers and consumers share the burden of the tax.
The way a tax affects people is called the tax incidence. The statutory incidence of a tax refers to the individuals or groups who must legally pay the tax. The statutory incidence reveals essentially nothing about a tax’s real burden, because as previously illustrated, prices may change in response to a tax. In contrast, the economic incidence of a tax refers to its actual effects on people’s incomes. The economic incidence of a tax depends on how buyers and sellers of the commodity react when the tax is imposed. The more sensitive consumers are to changes in price, the easier it is for them to turn to other products when the price goes up, in which case producers bear more of the tax burden. On the other hand, if consumers purchase the same amount regardless of price, they bear the whole burden.
