Tax Incidence

Tax incidence is the economic effect of a tax on the distribution of income and wealth. It is the distribution of the burden of a tax among the various economic agents in society.

There are two main approaches to tax incidence: the economic incidence and the statutory incidence. The economic incidence is the actual burden of the tax, while the statutory incidence is the legal burden of the tax.

The economic incidence of a tax is determined by the elasticity of demand and supply. If the demand for a good is elastic, then the burden of the tax will fall on the seller. If the supply of a good is elastic, then the burden of the tax will fall on the buyer.

The statutory incidence of a tax is determined by the law that creates the tax. For example, a sales tax is levied on the seller, but the burden of the tax may actually fall on the buyer. This is because the seller may pass on the cost of the tax to the buyer in the form of higher prices.

The difference between the economic incidence and the statutory incidence is known as the tax wedge. The tax wedge is the difference between the price that the seller receives and the price that the buyer pays.

Tax incidence is an important concept in public finance because it determines who actually pays the taxes. This can have a significant impact on the distribution of income and wealth in society.

In general, taxes that are levied on consumption goods have a progressive incidence, meaning that the burden of the tax falls more heavily on the rich than on the poor. This is because the rich consume a larger proportion of their income than the poor.

Taxes that are levied on income or wealth have a regressive incidence, meaning that the burden of the tax falls more heavily on the poor than on the rich. This is because the poor have a lower income and wealth than the rich.

The government can use tax incidence to achieve a variety of policy goals. For example, the government can use progressive taxes to redistribute income from the rich to the poor. The government can also use taxes to discourage certain activities, such as smoking or drinking.