Impact
and Incidence of tax
Introduction
First
of all, we should know what the term ‘Tax’ stand for to understand easily the
concept of the ‘Impact and Incidence of Tax’ and its effects on
an individual.
“Tax is a kind of money which it is the legal duty of very citizen of a country to pay honestly. It may be levied on income, property and even at the time of purchasing a commodity.”
The
burden of this tax does not always lie on the person who is imposed the tax in
first instance, it may also burden to other person. So the person who initially
pays the tax may not bear this burden, he can shift it to other person. Hence,
we need to know who bears the immediate burden of tax
and who bears the ultimate burden of a tax, as the
result we have to make clear the concept of impact of a tax and incidence of a
tax.
The
concept of impact and incidence of a tax:.
Tax
Impact or Impact of Taxation
Impact
of taxation refers to the immediate burden of the tax. The impact of a
tax is the immediate result of the imposition of a tax on the person who pays
it in the first instance.
The
impact of tax refers how introduction of taxation or the raising of tax
levels, on a particular product or service, affects usages of product or
service. The introduction or increase of tax, for example, usually results in
the product or service being purchased less often. As a result, the impact of
tax, or tax impact, is usually negative for the development of an economy, as
it hinders and reduces spending, which is necessary for the growth of an
economy.
Tax Incidence
Tax incidence is the degree to which a given tax is paid or borne by a
particular economic unit such as consumers, producers, employers, employees
etc. When we say that the tax incidence of a given tax falls on A,
it means A ultimately pays or bears the burden of tax in greater proportion.
Key terms:
- Incidence of a tax is the settlement of the tax burden on the ultimate tax-payer.
- The incidence of a tax refers to the money burden of a tax on the person who ultimately bears it.
- The incidence of a tax remains upon that person who cannot shift its burden to any other person.
- Tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply. ( François Quesnay)
Tax incidence is of two types: statutory incidence and economic
incidence.
Statutory incidence or nominal incidence of a given tax, is the degree
to which the tax is actually paid by an economic unit in the form of cash,
check etc. (Tax may be collected and deposited in government's treasury by
someone else). Statutory incidence is stated in tax law. For example, US tax laws require that
tax on salary income of an employee must be borne 50% by employer and 50% by
employee. In this case, statutory incidence of tax equally falls on employer
and employee.
Economic incidence of a given tax is the degree to which the burden
of the tax is borne by an economic unit in the form of reduced resources.
Economic incidence of a tax does not necessarily fall on the same economic unit
on which its statutory incidence falls. Rather it depends on the elasticity of
demand and supply. When demand is inelastic and supply elastic, tax burden is
mainly on the consumer; in case of inelastic supply and elastic demand, tax
incidence falls mainly on producer. When both demand and supply are moderately
elastic the tax incidence is distributed between producers and consumers.
Economic
tax incidence is explained in the following example:
Example
Suppose
a tax of Re.1 per unit is imposed on sale of product X. If the demand of the
product is perfectly inelastic and supply elastic, the suppliers will be able
to shift all of the economic incidence of the tax to consumers by restricting
supply causing increase in price of product X by Re.1. Producers will be able
to earn same amount of revenue as before the imposition of tax. Only consumers
will suffer in this case.
If the above Re.1 tax per unit is imposed under
perfectly inelastic supply, producers will have the bear all the burden of the
tax since they will not be able to control the price of the product when supply
is perfectly inelastic.
When both demand and supply are moderately elastic,
the product's price will increase slightly as a result of Re.1 tax per unit but
the increase will be lower than Re.1. Consumers will bear some burden of the
tax by paying slightly higher price. Producers will also face moderate tax
incidence because the increase in price is less than the tax per unit.
Differences between the two:
In short,
"The impact of taxation is on the producer while incidence of taxation on the consumers. The impact of tax can be shifted while incidence of tax cannot be shifted. The incidence of tax relates to the effects upon the people who pay the taxes, while the impact of tax relates to the effects upon the goods and services which are taxed."
There are different concepts of incidence of taxation given by different economists:
Dalton
classifies incidence of taxation:
Prof.
Dalton classifies incidence of tax into two categories, money burden and real
burden.
- Money burden: the money burden classified into two, direct money burden and indirect burden. According to Dalton, Direct money burden indicate that the burden of taxation in term of money lies on a person which the tax is levied. This means that one who pays the tax also bears the burden.
If
a tax is shifted, the incidence does not fall upon the person who shifts it.
For example, suppose a government impose tax on sugar at the sugar
manufacturing, so the money burden of the tax falls on the manufacturer of the
sugar directly.
If
a manufacturer enable to shift money burden of the tax to other person, say,
the wholesale dealer by means of raising the price of sugar i.e. shift money
burden, if the process of shifting continues from wholesaler to the final
consumer, the incidence is said to be on the final consumer who ultimate bears
the money burden, this Dalton calls the indirect money burden.
2. Real burden:
the real burden also classified into direct and indirect real burden of a
tax. The incidence of tax involves the shifting. According to Dalton,
similarly, the real burden of a tax is the sacrifice which the impression of a
tax entails on the tax-payers.
Direct
real Burden is the sacrifice of economic
welfare which has been made by the taxpayer as result of payment of tax. Indirect
real burden is the reduction in the
consumption of good by the taxpayer due to the imposition of tax.
K.
Hicks’ classified incidence of taxation
Mrs.
Ursula K. Hicks, also classifies incidence into two parts:
1. Formal
incidence
2. Effective
incidence of taxation.
These
two categories of incidence of taxation were adopted by the taxation Inquiry
Commission and study the problem of incidence of taxation in India.
The
Commission defined, “formal incidence s the money burden of taxes resting with
the subject on whom the burden is intended by the taxing author to fall and “
effective incidence is the real or final distribution of tax burden after its
shifting in consequences of changing demand and supply condition of taxed
commodity or services.
In
the sense of formal incidence of tax , prof. Dalton Calls as money burden of
tax and effective incidence as indirect money burden of tax.
Mus
grave concept of Incidence:
Mus
grave make three concepts incidence of taxation:
1. Absolute
or specific
2. Differential
3. Budget
balance
After
we discussed the concept of impact and incidence of tax, make us clear that it
effect on the consumer for example, suppose the government impose a tax on the
necessary goods which consumers consumer every-day-life. This tax, the sellers
will shift it forward to the consumers by means of increasing the price of the
commodities, as a result , the consumer has to spend more money to buy the same
amount of that commodity, so they have spend more. On the other hand, consumer
may reduce their consumption because of their income is limited, so their
standard of living decreased. For example, at the present government of India
increase tax on the petroleum, and this tax leads to increase the price of
petroleum in market. It is effect on the consumers because they need to spend
much more than before on their transportation, and everything in market because
of high cost o transportation, and production.
However,
this effect is also depend on the nature of demand and supply of the goods .
for example, if the demand is perfectly inelastic (ed=o) , the effect burden
fully on the consumer. The reason is that the consumer cannot decrease their
consumption, it may be because of their necessary need for everyday life etc ,
so whatever the price is , will purchase at same amount of the commodity.
If
demand is relatively inelastic, the more burden of the tax on the buyer than
the seller. Because, if the price of commodity increase or decrease the demand
increase or decrease less than the price.
If
demand is unit elastic, effect burden of the tax commodity are equally for the
both consumer and producer. Here, if the price increases one unit and the
demand of the consumer will decrease in one of commodity. The producer will
increase the price half of the tax that government imposed on the producer. So
50% for consumer and 50% for the producers.
“If
demand of commodity tax is elastic (Ed>1) the more burden of tax will be on
producer and consequently the less burden on consumer.”
“If
the demand is perfectly elastic (Ed=&), the full burden on the producer and
so on.”
To
sum up, the impact and incidence of a tax is the deference burden of taxation
to the tax-payer, one impose the tax to tax payer and he enable to shift it to
other person, it is impact of a tax, when this tax, when the ultimate burden of
the tax which consumer cannot shift, it is the incidence of tax. The effect of
this tax on the consumer and producer depend on the nature and the elasticity
of demand supply of the commodity.
THEORIES
OF TAX SHIFTING
1.
The Diffusion Theory
·
This theory states that
eventually, it becomes impossible to trace the final incidence of any tax and
that in reality, all taxes get diffused in the economic system.
·
It is based on the
assumption that the market is sufficiently competitive and that the factors of
production can move from one employment to the other quickly, easily and
without significant costs.
·
Because of the constant
interactions by sales/purchases transactions, a tax imposed at one place could
shift to all sectors of the economy thus becoming
untraceable.
2.
Demand and supply Theory
·
A tax may be shifted
through sale/purchase transactions depending on the elasticity of demand and
supply.
·
Shifting is through a
revision of prices.
·
If the demand is
inelastic, tax can easily be shifted by the seller to the buyer.
3.
Concentration Theory
The
tax should look on those having capability of paying tax that we need to look
on the units with surplus income
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