Tax Incidence

One of the worst-understood elements of any policy debate is the question of “tax incidence,” who actually pays a given tax. The public tends to put a great deal of weight on the legal question of who, exactly, is supposed to hand the check over. Meanwhile, business lobbyists invariably claim that costs will be “passed on to consumers” to bolster opposition to the tax even though if this were really true it’s hard to see why businesses would be so upset.

Stephen Gordon has an excellent post laying out the truth, which is that statutory incidence is irrelevant and real incidence depends on elasticity. I’ll just copy his charts, click through if you want a detailed explanation. But first, as you can see here taxing buyers and taxing sellers has the exact same impact:

Incidence1 1

What does make a difference is changing your assumptions about elasticity:

Incidence2 1

Of course things can get more complicated in the long run. A tax on Pepsi would initially have little impact on consumers, since a close substitute (Coke) is available and Pepsi would mostly just lose money. But if the tax managed to drive Pepsi out of business, Coke would have more market power and prices could end up higher than ever. Or if you raise gasoline taxes, the short-run impact is going to be to cost people money since the elasticity is low, but the long-term elasticity looks different and eventually people will buy more efficient cars and municipalities will invest in less car-dependent infrastructure and oil companies will take a big hit.