Friday, 1 August 2008

When Taxes Change, Who Pays?

"Tax incidence" is the analysis of who actually bears the burden of a tax.

In setting any tax policy it is important to assess how a given tax affects those involved in a given transaction. In general, the tax incidence is split between the producer and consumer. This is in contrast to the 'flypaper theory' of tax incidence which naively assumes that the tax sticks wherever it first lands.

An explanation of tax incidence can be found on Wikipedia, where there are graphs showing the effects on different elasticities of supply and demand (i.e. how much increased prices cause a drop in demand, or an increase in production). There is also a good explanation at the Institute for Fiscal Studies which looks uses the important example of the effect of a Vodka Tax.

Here, I'll have a look at the current situation of taxes on road fuel.

[TODO: look up research on elasticity, and see if I can quantify the situation. Supply seems rather inelastic, hence massive variation in price as demand rises and falls]


Jock Coats said...

I'm rather hoping you will reinterpret that to show to us all why switching from incomes/payroll taxes to land based taxes will a. increase net wages and b. not be able to be passed on by landlords.


Robin Smith said...

Not sure if I understand tax incidence correctly but this is quite interesting for road fuel duty and the proposed 2p increase :

For private motorists who are at the end of the supply chain for tax on fuel, the burden always falls on them even though it has been shown over the past year that they are quite elastic on overall fuel price and have reduced mileage by up to 20% in some reports. Is this because the transaction tax falls directly on them and they have nowhere to go.

For the independent haulage driver, who still has a factor of production to pay for in the fuel for delivering the goods as part of the service, it seems clear the tax incidence is more upon them. They are inelastic as they do not feel they can pass on 'any' incremental fuel taxes for fear of losing business to the more powerful competition, not to mention the overall increases in fuel price. Their grievance might be justified as they feel they are paying the most tax

For the big haulage companies the incremental costs can be soaked up by the large buffers it has to play with. So are they implicitly the beneficiaries of anti competitive tax policies with road fuel duty?

If I understand this right it shows how meddling without understanding the full impact is so wrong headed and damaging?

Fiscal Reformer said...

Jock: Net wages rise because the net economic product of the population rises. Remember that wastage and lost opportunity represents an economic loss and so reduces wages. The effect of taxes on jobs is to cut net pay somewhat and increase labour costs somewhat, depending on the relative elasticities of supply and demand for labour.

Landowners currently charge what the market will bear for access to their land. A tax on the landowners will not change this. They will carry on charging what the market will bear.

Viewed from the perspective of tax incidence theory, land supply is completely inelastic, and therefore bears all the tax burden.

Viewed from the perspective of supply and demand curves, the tax does not alter the supply curve (which is a vertical line - any price (y axis) gives fixed quantity (x axis)). Supply and demand curves intersect at the same point, regardless of a land value tax. So none of the tax ends up coming from the demand side (ie "tenant").