NCPA - National Center for Policy Analysis

Who Should Bear the Burden of Tax Increases?

October 10, 2012

Debates over tax increases often end in discussion of who should bear the burden. The entity with the obligation to remit the tax revenues to the taxing authority may not be the entity that pays the tax. Tax incidence, as it is referred to, occurs when the entity that incurs the tax shifts the burden onto another entity. For example, if a $1 tax is imposed on retailers for butter by the federal government, then the retailer would shift the burden to consumers or someone in the production process, say Cecil E. Bohanon, a professor of economics at Ball State University, and Brandon M. Pizzola, an MA Fellow at the Mercatus Center.

Traditionally, the impact of tax incidence has looked at price elasticity of demand and of supply. If the supply is inelastic, then consumers are willing to pay the increase. Moreover, if the supply is inelastic, then the quantity of a good is unlikely to change as well. However, it is possible that the supply for a good is more elastic than the demand, creating a more nuanced theory for explaining the tax incidence based on supply and demand.

  • The party that is responsible for remitting the tax revenue to the government has little to do with who bears the tax burden.
  • The party who remits the tax revenue can't shift the tax burden.
  • The split of the tax burden is determined by the market.
  • Furthermore, the split of the tax burden depends on the relative elasticity of supply and demand.
  • Finally, the side of the market that is less elastic bears more of the tax.

There are empirical examples to support the aforementioned theory of tax burdens being unequal. For instance, take federal and state taxes on gasoline:

  • The inelasticity of gasoline would normally mean that consumers bear the full burden of any taxes.
  • Yet, at the federal level, consumers and wholesalers pay roughly half of the tax.
  • But at the state level, consumers typically bear the full burden.

The popular belief that the tax burden is only on the party that has to remit the tax is false. Rather, the theory and empirical examples show that tax incidence is determined by market forces that assess the elasticity of the supply and demand of a product.

Source: Cecil E. Bohanon and Brandon M. Pizzola, "Who Pays the Tax? Theoretical and Empirical Considerations of Tax Incidence," Mercatus Center, September 24, 2012.


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