Tax Incidence (Tax Burden)

Concepts

  • Excise Tax (Per-Unit Tax)
    • Impact on Supply Curve
  • Price Paid by Buyers (PB)
  • Value of the Per-Unit Tax
  • Price Received by Sellers (PS)
  • Determining Who Bears the Larger Burden of the Tax
    • Inelastic Demand: Consumers Bear the Larger Burden of the Tax
    • Elastic Demand: Producers Bear the Larger Burden of the Tax
    • Perfectly Inelastic Demand: Consumers Bear the Entire Burden of the Tax
    • Perfectly Elastic Demand: Producers Bear the Entire Burden of the Tax

Overview

Tax incidence deals with determining if the consumer or the producer bears the larger burden of a tax.  To make this determination, the first thing we need to understand is the tax itself.  An excise tax is usually what gets referenced in these types of questions.  Think of an excise tax like a sales tax, or a per-unit tax that creates one more obstacle for producers to overcome in order to get their product in the hand of their customers.  As a result of this, I hope you can see that an excise tax will shift the supply curve to the left.  Now the question becomes: How much of that tax can producers pass on to the consumer in the form of higher prices?  To determine who bears the larger burden of this tax, we need to know the elasticity of demand.  If consumers have inelastic demand, that means they CAN’T be as responsive to a change in price because they have less power in the transaction.  As a result, the consumer will bear the larger burden of the tax.  If consumers have elastic demand, that means they CAN be more responsive to a change in price because they have more power in the transaction.  As a result, the producer will bear the larger burden of the tax.  We conclude by addressing the extremes of elasticity.  Producers have complete power when there is perfectly inelastic demand.  This allows producers to pass on the entire tax onto the consumer in the form of higher prices.  Consumers have complete power when there is perfectly elastic demand.  Producers bear the entire burden of the tax beecause they are not able to pass on any of the tax onto the consumer in the form of higher prices.

Materials

Lecture

Tax Burden – Inelastic Demand Video

 

Tax Burden – Elastic Demand Video

 

Tax Burden Lecture Video

Quiz

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