11.1. Meaning ?
 If you have a lunch in a restaurant and your bill
includes with some tax, does it mean that the
charged tax is paid all by yourself?
Answer: It may not. You may share the paid tax
with the restaurant’s owner
 Tax incidence
Who does really pay the tax charged on goods,
such as a lunch that you eat in the restaurant ?
 Consumer, or producer or both
11.2. Tax Incidence in
Competitive Markets
 Effect of Tax at Firm Level
Price
S1
S1
So
Po
 Tax
Makes a firm
reducing its
production
from qo to q1
Tax rate t
q1
qo
Quantity
 Effect of Tax at Market Level
Price
S1
S1
So
Tax rate t
Po + t
 Tax
Makes price
increasing from
Po to P1,
and transaction
decline from Qo
to Q1
P1
Po
Q1
Qo
Quantity
 Tax Incidence: Who Pay for Tax
Price
S1
S1
So
Tax rate t
 Tax
causes price
increases from
Po to P1, and
transaction declines
from Qo to Q1
 Consumer’ tax
contribution P1-P2
 Producer’s tax
(P1-P2)
P1
Po
P2
Q1
Qo
Quantity
 No Matters Whether Tax is Levied
on Consumers or Producer
Price
Do
So
Pajak t
D1
P1
Po
P2
Q1
Qo
Quantity
 Tax levied on
consumer
Makes demand
shifting from Do ke D1,
and transaction
declines from Qo
to Q1
 Consumer pays old
price P2 and tax rate t
 Price becomes P1
 Consumer’s share on
tax = P1 – Po
 Producer’s share
(Po-P2)
11.3. Ad valorem Tax versus
SpecificTax
 Ad valorem tax
 Tax whose rate is percentage of price
For instance, t = 20 % of P
Specific tax
Tax whose rate is a fixed amount per unit of
product (t)
 For instance, t = Rp 500 / kg
Price
 Effect of Ad Valorem Tax versus Effect Specific Tax:
Same on revenue and output
Specific tax , Rp t per Kg
Do
P2=
Po + tax
So
D1
P1
Po
Tax rate: c % dari harga
D3
Q1
Qo
Quantity
11.4. Effect of Elasticity on
Tax Incidence
 If Demand is perfectly Inelastic, all tax is born
By consumer
Price
Tax rate t
Do
S1
P1
So
Po
Q1
Qo
Quantity
 If Supply is perfectly elastic, all tax is born by consumer
Harga
Do
Pajak t
S1
P1
Po
So
Q1
Qo
 If Supply perfectly Inelastic,
all tax is born by producer
Price
Do
S  Supply curve before
and after tax
Po=P1
Qo=Q1
Quantity
 If demand is perfectly elastic, all tax is born Producer
Price
S1
Tax t
S0
Po=P1
Do
Q1
Qo
Quantity
11.5. Tax Incidence on Wages
 Levying
tax on wages will reduce
demand for labor by firm
Since, the tax will cause production
cost increase
 Analyzing Tax Incidence on Wages and
Labor Demand
Wages
S
Tax
Wo +
tax
Tax borne by firm
Wo
W1
Do
D1
L1
Tax born by laborer
L0
Labor
11.6. Readings
Stiglitz, Joseph E. 2000. Economics of the Public
Sector. New York, USA: W.W. Northon and
Company (Chapter 18)