Incidence and Distribution

There are four principles in the analysis of tax incidence: 1. The entire burden of a tax must be traced to individuals. Businesses may remit taxes, but only individuals–shareholders, employees, customers–can bear the burden of taxes. 2. The ultimate distribution of the tax burden may di¤er from the statutory liability; that is, the tax burden may be shifted because prices change. 3. The long run e¤ect of taxes does not usually depend on which side of the market the statutory liability is placed. 4. The better the alternatives one has to the taxed good or activity, the less likely one is to bear the burden of the tax. Our analysis so far has assumed a single homogenous type of labor and a …xed pre-tax wage. If there are two types of labor, skilled and unskilled, increasing the tax on skilled labor may decreased the supply of that labor, thereby increasing the pre-tax wage. Similarly, a tax on capital income may encourage capital ‡ight, decreasing productivity and the wage rate in the taxing country. Simple models also assume that the only thing consumers sell is their labor, ignoring the fact that while an increase in the price of a good makes those who buy it worse o¤, it also makes those who produce it better o¤. The incidence of a tax may shift because the tax causes prices to change in the taxed market or in other markets. A tax on yachts will increase the price of yachts, causing fewer yachts to be bought. The new, after-tax price is not necessarily equal to the old price, so that the burden of the tax falls not just on those who buy yachts, but also those who produce them. A tax on butter will cause substitution toward margarine, driving up the price of margarine. Margarine buyers are worse o¤ and margarine producers are better o¤ even though the tax was imposed in a di¤erent market. Statutory liability can a¤ect incidence in some situations. Statutory liability can also a¤ect the e¢ ciency of the tax system. Employers may have an advantage in record-keeping because of economies of scale, so having employers remit the taxes means a lower cost for collecting given revenue. If evasion opportunities di¤er based on who remits the taxes, changes in statutory liability can a¤ect incidence. With noncompetitive behavior, ad valorem and unit taxes do not have the same e¤ect. Ad valorem taxes lower prices and increase quantity more than unit taxes.