Tax Incidence / Tax Burden

Tax Burden

• Tax burden (or tax incidence) means the amount of tax that has to be paid by the buyer or seller.
• It is always the more inelastic curve that pays more of the tax burden. Example: If the demand is more inelastic, the consumers will pay

  more

  ---

  of the tax burden. Demand is inelastic for cigarettes (for consumers that are addicted), so the cigarette company can pass along a lot of the tax to the consumer in the form of a higher price.

Inelastic Demand and/or Elastic Supply

• To determine the tax burden on consumers, take the difference between the new price paid by consumers and the original equilibrium price. In the diagram above the tax burden (incidence) on consumers is

  13 - 10 = $3

  ---

• To determine the tax burden on producers, take the difference between the original equilibrium price and the new price received by producers. In the diagram above the tax burden on producers is

  10 - 9 = $1

  ---

• As a percentage, consumers are paying

  3/4 = 75%

  ---

  of the tax and producers pay

  1/4 = 25%

  ---

  of the tax.

Elastic Demand and/or Inelastic Supply

• If the demand is more elastic, the consumers will pay

  less

  ---

  of the tax burden Example: The demand for Pepsi is generally elastic, so if the company tries to pass along a lot of the tax to the consumers, they will just switch to other products like Coke, Sprite or Mountain Dew.

• In the diagram above the tax burden (incidence) on consumers is

  11 - 10 = $1

  ---

  and tax burden on producers is

  10 - 7 = $3

  ---

• As a percentage, consumers pay

  1/4 = 25%

  ---

  of the tax and producers pay

  3/4 = 75%

  ---

  of the tax.

Tax Incidence / Tax Burden with Perfectly Elastic and Inelastic Curves

• If Demand is perfectly inelastic or Supply is perfectly elastic, consumers will pay

  all

  ---

  of the tax.
• If Demand is perfectly elastic or Supply is perfectly inelastic, producers (sellers) will pay

  all

  ---

  of the tax.

Perfectly Inelastic Demand

• In the diagram above, the original equilibrium price was

  $10

  ---

  and quantity was

  20

  ---

  .
• With a tax the supply shifts left (upward) from S to S1.
• The new equilibrium price of

  $14

  ---

  is the price paid by consumers. This means consumers' tax burden is

  14 - 10 = $4

  ---

• To find the price producers receive we take the new quantity (which is still 20) and plug it in the original supply curve which gives us a price of

  $10

  ---

  . This means the producers' tax burden is

  10 - 10 = $0

  ---

  .
• This shows that consumers pay all of the tax.

Perfectly Elastic Demand

• In the diagram above, the original equilibrium price was

  $10

  ---

  and quantity was

  20

  ---

  .
• With a tax the supply shifts left (upward) from S to S1.
• The new equilibrium quantity is

  15

  ---

  and the new equilibrium price is still

  $10

  ---

  which is the price paid by consumers. This means consumers' tax burden is

  10 - 10 = $0

  ---

  .
• To find the price producers receive we take the new quantity (which is 15) and plug it in the original supply curve which gives us a price of

  $6

  ---

  . This means the producers' tax burden is

  10 - 6 = $4

  ---

  .
• This shows that producers pay all of the tax.

Example: Tax Incidence / Tax Burden