• Taxes • Subsidies Case 1 : Tax • Consider market for chocolates • Suppose government taxes an amount of 5 rupees per piece sold • The sellers’ forum says it cannot pay the whole tax • It is decided to equally share tax burden between buyers and sellers • Is it always possible??? - NO • Question is: Who bears the burden of the tax then ? • Distribution of tax burden is called “incidence of tax” Tax on Sellers
Buyers pay more than
before and sellers receive less than before
Tax on Buyers and Tax on Sellers are Equivalent
Tax on Buyers
Buyers pay more than
before and sellers receive less than before Key Takeaway It does not matter whether the sellers or buyers are legally taxed. The ultimate outcome is the same!
Then what determines the extent of tax burden borne by sellers and buyers respectively ?
Elasticity ! Elasticity and Tax Incidence-I Elasticity and Tax Incidence-II Intuition behind the sharing of tax incidence
ELASTICITY = ESCAPE
• Elastic demand means demanders have more substitutes for the product taxed and so can escape the tax • Elastic supply means the resources can be moved to other industries and so the suppliers can escape the tax • The side which is relatively less elastic must bear the greater burden of the tax Costs of Taxation Deadweight losses are the values of the trades/transactions not executed in the market because of the tax. No Elasticity =No entry of suppliers
