Incidence of a Tax and the Elasticities of the Prices Supply and Demand
Taxes are often targeted at individuals or companies, but how does the construct of the economy effect who actually pays the tax?
An incidence of a tax is how the share of a tax falls on either the producer or consumer. More simply, the incidence of a tax is a measure that determines who pays the tax. The incidence of a tax is determined by the price elasticity of the supply and demand. The price elasticity is a measure of how susceptible the supply or demand for a good or service is to a change in price. The lower the price elasticity of demand, the higher the tax incidence is on the consumer.
In an oligopoly, like we have in the US, the price elasticity of demand is pretty elastic. This means that price increases in consumer goods has a smaller impact on the demand for the good. This is especially true for goods like gasoline, electricity, cellular phones, automobiles, prescription drugs, and education, among many other things.
When taxes are placed on consumer goods in oligopolies, whether they are levied on the goods or the company that manufactures the goods, the companies are in a position of power to pass the majority of those taxes onto the consumer in the form of higher prices. Companies can factor the tax into the pricing formula as part of their variable costs, which will raise the selling price for the consumer market. The reason companies in an oligopoly are able to pass so much of the price of the tax onto consumers is because companies in an oligopoly are price setters, not price takers.
These companies are given a lot of latitude in establishing monopolistic type industries because of the US’ patent policy. There are two major US cell phone providers, Apple and Samsung, those companies own a majority of the market share on cell phones. This means that Apple and Samsung can pass the majority of the taxes onto the consumer because it is unlikely that the price change will drive Apple or Samsung devotees to Nokia.
It is for this reason that corporate taxes are inefficient in the execution of their stated goal. The proponents of higher corporate income taxes wish to extract funds from those companies to expand social welfare and safety net programs. The unintended consequence is that those same corporations are capable of passing those taxes on to consumers in the form of price hikes. When this happens, consumers get taxed for an n(th) time. Consumers are paying payroll taxes, income taxes, interest taxes, property taxes, sales taxes, real estate taxes, inheritance taxes, estate taxes, and now a large portion of the corporate taxes.
It important to understand how price elasticity factors into the incidence of a tax when considering the implementation of a new tax. Too often, it appears, that legislators are not considering the second and third order effects of taxes, and do not end up taxing the target demographics with a given tax.
