Chapter 19: Equity Implications of Taxation: Tax Incidence

Tax cuts and Jobs Act of 2017

• largest tax overhaul in 3 decades

• significant change reduction of corporation tax from 35% to 21%

statutory burden of a tax

does not describe who really bears the tax (rule 1)

side of the market on which the tax is imposed

is irrelevant to the distribution of the tax burdens (rule 2)

parties with inelastic supply/or demand bear taxes…

parties with elastic supply or demand avoid them (rule 3)

statutory incidence

the burden of a tax borne by the party that sends the check to the government

economic incidence

• burden of taxation measured by the change in the resources available to any economic agent as a result of taxation 

• includes the tax payments paid and any price changes caused by the tax

consumer tax burden

(post tax price - pre tax price) + per unit tax payments by consumers

producer tax burden

(pre tax price - post tax price) + per unit tax payments by producers

tax wedge

the difference between what consumers pay and what producers receive (net of tax) from a transaction

gross price

the price in the market

after tax price

the gross price minus the amount of the tax (if producers pay the tax)/or plus the amount of the tax (if consumers pay the tax)

does economic incidence depend on the statutory incidence 

no, it is determined by the elasticities of supply and demand

what happens if one side of the market is perfectly inelastic

then it bears the full burden of the tax, there is full shifting of the tax burden to that side of the market 

full shifting

when one party in a transaction bears all of the tax burden 

what are general cases

• the less elastic demand relative to supply, the large share of the incidence falls on demand

• demand for goods is more elastic when there are many substitutes

• for products with an inelastic demand, the burden of the tax is borne almost entirely by the consumer

what same principles hold for supply as for demand elasticities

elastic factors avoid taxes, whereas inelastic factors bear them

balanced budget incidence

tax incidence analysis that accounts for both the tax and the benefits it brings —> hard to determine who benefits from a given tax increase

what does tax incidence analysis assume 

prices can freely adjust, but wages cannot fall below the minimum wage

minimum wage

legally mandated minimum amount that workers must be paid for each hour of work 

what does the barrier to price adjustment change

the incidence of the tax burden 

partial equilibrium tax incidence

analysis that considers the impact of a tax on a market in isolation

general equilibrium tax incidence

analysis that considers the effects on related markets of a tax imposed on one market

effect of time period on tax incidence: short run v long run

• factors that are inelastically demanded or supplied in both the short/long run bear taxes in the long run

• investments are irreversible, so supply of capital is inelastic in the short run

• investors have many opportunities, so in long run, elasticity of capital may be high

what does tax incidence depend on

• how broadly the tax is applied

• taxes that are broader are harder to avoid than narrower taxes, so response of producers and consumers to the tax will be smaller and more inelastic

• tax on local restaurant has a diff incidence than a tax on all restaurants

what are the 3 effects a higher after tax price on other goods

• income effect from lower real income

• substitution effect toward goods that are substitutes for restaurants

• complementary effect 

complementary effect

consumers may reduce their consumption of goods/or services that are complements to restaurant meals 

tax policy center incidence assumptions

• income taxes are borne fully by households that pay them

• payroll taxes are borne fully workers

• excise taxes are fully shifted to prices and so are borne by individuals in proportion to their consumption of the taxed item

• corporate taxes are borne by 20% workers & 80% by owners of capital

current tax incidence

the incidence of a tax in relation to an individual’s current resources

lifetime tax incidence

the incidence to an individual’s lifetime resources

conclusion

the fairness of any tax reform is one of the primary considerations in policy makers’ positions on tax policy