What is a Tax Incidence?

M. McGee

In some circumstances, it is possible to pass the cost of a tax on to another group; tax incidence establishes what group actually pays a tax. This process follows a tax from its origin through all of the economic layers to the final payer. In many cases, it is a person several steps removed from the actual tax that bears the greatest burden.

Man climbing a rope
Man climbing a rope

While it may seem as though the person paying the tax would bear the tax incidence, this is not always so. Certain taxes are levied against a particular group but, rather than paying those taxes, it passes them on to another group. A person paying the actual tax, the one that fills out the forms, pays a nominal tax incidence. This form of tax incidence is rarely the last step in the process.

Generally, a person passes their expenses onto others whenever possible. If a tax is levied on a manufacturer, it passes the extra cost on by raising the price. If the company that uses the goods for a finished product then needs to pay more, it raises the price. The goods will then go on to a retailer who is suddenly paying more for a stocked product. The retailer will either accept the increased price or pass it onto its customers.

Each of these steps is a separate link in a chain. While the initial person had nominal tax incidence, he was only the first link. Each location, including the first, likely paid a small amount of the tax. Even so, one group nearly always pays the majority. This group is the true payer of the tax.

Generally, a business product tax trickles down to a retailer or a customer. The manufacturers and suppliers raise the cost of their portion of the product to account for the new price. A retailer needs to determine if its customers will purchase the product at a higher cost; if they won’t, then the retailer pays the tax. If the retailer feels people will still buy the product with a higher price, then the customer pays it.

This trickle down system isn’t always in action. In circumstances where the product is available from many sources, the tax is local or the good is seasonal or perishable, tax incidence will happen further up the chain. For example, if a person is growing oranges and a tax is levied against oranges by a county government, the grower would likely need to pay it alone. Since oranges can come from many locations and not all of them have the tax, the grower would need to keep his prices low to remain competitive. Since the good is perishable, the grower doesn’t have the luxury of stockpiling oranges until prices even out.

You might also Like

Readers Also Love

Discuss this Article

Post your comments
Forgot password?