Tax Burden: Who Really Pays?
1. Statutory vs. Economic Burden
The statutory burden is simply who is legally responsible to pay the tax to the government. For example, when you buy a toy, the store collects a sales tax from you and sends it to the government. You are bearing the statutory burden. However, the economic burden looks at who really loses purchasing power or income because of the tax.
2. Tax Incidence on Buyers and Sellers
Tax incidence [1] describes how the burden of a tax is divided between buyers and sellers. Imagine a new $1 tax is placed on each cup of lemonade sold by a teenager. The supply curve shifts up. The new price for buyers might rise by $0.60, and the seller now keeps $0.40 less than before after paying the tax. In this case, the economic burden is split: buyers pay more, and sellers earn less. The division depends on how sensitive buyers and sellers are to price changes.
| Scenario | Price Paid by Buyer | Price Kept by Seller (after tax) | Economic Burden |
|---|---|---|---|
| Before $1 Tax | $2.00 | $2.00 | None |
| After $1 Tax | $2.60 | $1.60 | Buyer: $0.60; Seller: $0.40 |
3. Real-World Example: The Payroll Tax
In many countries, a payroll tax is officially split 50/50 between the firm and the worker. Legally, the firm pays half and deducts the other half from the worker's paycheck. However, economists argue that the worker bears almost the entire economic burden. Firms view the total cost of hiring an employee (wage + their half of the tax) as the price of labor. If that total cost is too high, they will hire fewer people or offer lower wages. So, even the firm's official half is ultimately paid by the worker through lower wages than they would otherwise receive.
4. Practical Example: Tax on Luxuries vs. Necessities
Consider a tax on yacht purchases. Wealthy buyers can easily choose not to buy a yacht, or buy it in another country. The demand is elastic [2]. However, yacht builders and their workers cannot easily change jobs. The supply is inelastic. Therefore, if a tax is imposed, the yacht builders and workers bear most of the tax burden by accepting lower prices for their labor and materials to keep their jobs. Now consider a tax on insulin, a life-saving medicine for diabetics. Demand is very inelastic [3]. Consumers will pay almost any price. In this case, the tax burden falls almost entirely on the diabetic patients.
5. Corporate Income Tax Burden
When the government raises the corporate income tax, who pays? A corporation is a legal entity, not a person. It cannot truly bear a burden; only people can. The economic burden of a corporate tax is shifted to three groups:
- Shareholders (owners): They receive lower profits and dividends.
- Employees: They receive lower wages or fewer jobs, as the company cuts costs.
- Customers: They pay higher prices for the goods and services.
Important Questions
A: No, the store is just the collector. The customer bears the statutory burden by paying the extra 10%. However, if the high price causes customers to buy less, the store might have to lower its pre-tax price to stay in business, thus sharing the economic burden.
A: Not always. It depends on the shape of the supply and demand curves. If demand is very flat (elastic), the seller might have to absorb most of the tax to avoid losing too many customers. The price increase will be less than the tax.
A: In a competitive market, a business cannot easily avoid its share of the burden. If it tries to raise prices too much to cover a new tax, it will lose customers to competitors. If it tries to lower wages too much to compensate, it will lose workers. The burden is determined by market forces beyond any single business's control.
Conclusion
Footnote
[1] Tax Incidence: The analysis of the effect of a particular tax on the distribution of economic welfare. It answers the question of who bears the real burden.
[2] Elastic: When the quantity demanded or supplied responds significantly to changes in price.
[3] Inelastic: When the quantity demanded or supplied responds very little to changes in price.