Tax Incidence

As per the tax incidence meaning, it is an important economic term that is utilized for understanding the division of tax burden amongst stakeholders –like the buyers, sellers, consumers, or producers. Tax incidence is also known to be associated with the overall price Elasticity of the existing demand and supply.

When the supply tends to be more elastic in comparison to the demand, the ultimate tax burden is known to fall onto the buyers. On the other hand, when the demand tends to be more elastic in comparison to the supply, it is the producers who are going to bear the overall burden of the tax.

How Does Tax Incidence Work?

The phenomenon of tax incidence is known to depict the overall distribution of the respective tax obligations. The obligations are expected to be covered by both the buyers as well as the sellers. The given level at which every party will be participating to cover the Obligation is known to shift on the Basis of the linked price elasticity of the good or service in question. At the same time, it also shifts the manner in which the good or service would be currently affected by the demand & supply principles.

Tax incidence is known to reveal the specific group –producers or consumers, that will be paying for the consecutive price of the all-new tax. For instance, the overall demand for prescription drugs tends to be relatively inelastic. Even after the overall changes in the cost, the respective Market is going to remain constant relatively.

Inclusion of New Taxes on Elastic & Inelastic Goods

Another common instance of tax incidence is that the overall demand for cigarettes tends to be highly inelastic. When the government would impose the cigarette tax, the respective producers tend to increase the overall sales price by the full tax amount. This, in turn, transfers the overall tax burden on the end consumers. With in-depth analysis, it is observed that the demand for cigarettes tends to be unaffected by the rise in price. Indeed, there are specific limits to the given theory. In case the pack of cigarettes would be suddenly increased in price from INR 5 to INR 100, then the consumers’ demand would ultimately fall.

If new Taxes are imposed on elastic items –like fine jewelry, then most of the tax burden will be likely shifting to the producers. This is because with the rise in price, it tends to have a significant impact on the overall demand of the linked goods. Elastic goods tend to be items featuring close substitutes or that might be non-essential.

Tax Incidence and Price Elasticity

Price elasticity is referred to as the measurement of how the activity of buyer tends to change as a response to the respective movements in the cost of the products or services. When the costs of goods or services would be profoundly impacting the demand’s level, the demand is regarded as highly elastic.