NPTEL-Economics-Public Economics
Module 8
TAX BURDEN
Lecture (31 - 32)
Topics
8.1 Distribution of Tax Burden
8.2 The Three Rules of Tax Incidence: Inelastic Versus
Elastic Supply and Demand
8.3 Tax Incidence
8.4 Extensions of Basic Partial Equilibrium Analysis
8.5 Tax Incidence in Factor Markets
8.6 Tax Incidence Extensions
Tax Incidence in Factor Markets
8.7 Tax Incidence in Imperfectly Competitive Markets
8.8 Formula for Tax Incidence
1
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
Module 8
Lecture 31
Topics
8.1 DISTRIBUTION OF TAX BURDEN
The side on which the tax is imposed is irrelevant for the distribution of tax
burdens.
The distribution of tax burden depends on the elasticity of demand and supply
Figure 31.1
(1) In all cases, elastic parties avoid taxes & inelastic parties bear the taxes.
Case I (Figure 31.1)
Consumer tax burden = (2-1.5) + 0 = 0.50
(post tax price – pre tax price) + tax payment (is what the consumers are paying, so must
be added).
Produce tax burden = (1.5 - 2) + 0.5 = 0.
2
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
Figure 31.2
Case II (Figure 31.2)
Consumer tax burden = (1.5 – 1.5) + 0 = 0
Producer tax burden = (1.5 – 1.5) + 0.5 = 0. 5
8.2 THE THREE RULES OF TAX INCIDENCE:
INELASTIC VERSUS ELASTIC SUPPLY AND
DEMAND
Note that even though the tax was legally imposed on the producer, the full
burden of the tax is borne by the consumer.
Full shifting is when one party in a transaction bears all of the tax burden.
– With perfectly inelastic demand, consumers bear all of the tax burden.
– With perfectly elastic demand for, producers bear all of the tax burden.
Figure 31.3 a
3
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
Figure 31.3 b
Holding demand constant, more elastic supply leads to a greater Tax burden on
consumers.
Less elastic
smaller tax burden on consumers.
8.3 TAX INCIDENCE
There are three basic rules for figuring out who ultimately bears the burden of
paying a tax.
– The statutory burden of a tax does not describe who really bears the tax.
– The side of the market on which the tax is imposed is irrelevant to the
distribution of tax burdens.
– Parties with inelastic supply or demand bear the burden of a tax.
While there is only one market price when a tax is imposed, there are two
different measures of price.
– The gross price is the price in the market.
– The after-tax price is the gross price minus the amount of the tax (if
producers pay the tax) or plus the amount of the tax (if consumers pay the
tax).
– Finally, it is important to note that even though quantities change
dramatically with perfectly elastic demand, the focus of tax incidence is on
prices, not quantities.
4
Indian Institute Of Technology, Kanpur