Incidence of taxation and features

Incidence of taxation, What is tax incidence? The incidence of taxation refers to the point at which the tax burden finally rests. The burden here refers to the amount paid as tax. The incidence or burden of taxation, therefore, lies on the person who finally pays the tax.

Tax incidence refers to the way the burden of a tax is distributed among different individuals or groups in an economy. It is concerned with understanding who ultimately bears the economic burden of a tax, whether it is the individuals or entities directly paying the tax or others who may be affected by the tax indirectly.

Tax incidence is determined by the relative price elasticity of demand and supply for the taxed good or service. The elasticity measures how sensitive the quantity demanded or supplied is to changes in price.

In general, the tax burden tends to be shared between buyers and sellers, depending on the price elasticities of demand and supply. If the demand for a good is inelastic (not very responsive to price changes) and the supply is elastic (responsive to price changes), then the burden of the tax will primarily fall on the buyers. This is because they are less able to adjust the quantity demanded in response to price changes, and the tax effectively increases the price they have to pay.

Types of Incidence of taxation

Formal incidence: This refers to the initial effects of the tax on the tax object i.e. the taxpayer. It shows where the initial burden of taxation lies. For direct tax the initial burden of tax is borne on the payer. The producers or manufacturers bear the initial burden of tax in case of indirect taxes

Effective incidence: The effective incidence of tax makes references to those that bears the final burden of taxation. With reference to direct taxes, the payer bears the full (initial and final) burden of taxation. $\"problems$

For instance, a person who pays income tax bears the full burden of tax and cannot shift it to another person. In the case of indirect taxes, the burden of taxation may be borne by the producer (seller) or the consumer or shared between them.

The extent to which either or both of them bear the burden of taxation will depend on the elasticity of demand for the commodity which is taxed. Incidence of taxation

features of incidence of tax

Incidence of indirect tax when demand is perfectly inelastic: The burden of an indirect tax on a commodity whose demand is perfectly inelastic is borne by the consumer. In this case, the whole tax burden can easily be shifted to the consumer by the producer (or seller) in the form of higher prices because the increase in price does not bring about any change in quantity demand. The incidence of taxation $\"Incidence$

tax is represented by AB. This tax increases the manufacturer’s cost of production. Since the same quantity is purchased irrespective of the price, the manufacturer increases the price of the product from PI to P2. The consumer bears the full burden represented by the rectangle Incidence of taxation

Incidence of indirect tax when demand is perfectly elastic: If demand for a commodity is perfectly elastic, the producer or seller will bear the whole burden of taxation.

This is so because any attempt to increase the price will make the demand for the product fall to zero. The tax burden in this situation cannot be passed to the consumer.

tax is represented by EF. Since the tax increases the manufacturer’s (seller) cost of production, the quantity supplied decreased from Q1 to Q2.

However, the price remains at P since any attempt to increase the price will make demand to drop to zero. The manufacturer or seller retail trader-– therefore bears the whole tax burden represented by rectangle PEFG.

Incidence of indirect tax when demand is moderately elastic or moderately inelastic: If the demand is moderately elastic or moderately inelastic, the burden of taxation will be shared between the producer (or the seller) and the consumer. The more inelastic the demand for the commodity, the more burden of tax is shifted to the consumer. On the other hand, the more elastic the demand for the commodity, the greater the burden of taxation the producer (or seller) bears.

the producer or seller bears the tax burden represented by P1HIJ while the buyer bears P2GHP1. The producer, therefore, bears the greater burden. But in 32.4, the area which represents the burden borne by the consumers is larger than that of the producer or seller.

Incidence of tax when demand is unitary: If demand is unitary, the tax burden is shared equally between the producer (or seller) and the consumer.

the producer passed half of the tax burden to the consumer in the form of higher prices.

The tax is represented by RT, and the price increases from P1 to P2. The tax burden borne by the consumer is represented by P1SRP2 while the tax burden borne by the seller or producer is represented by VTSP1. The two rectangles are equal because both the consumer and the producer bear incidence of taxation equally.