What is a 'Tax Incidence'

A tax incidence is an economic term for the division of a tax burden between buyers and sellers. Tax incidence is related to the price elasticity of supply and demand, and when supply is more elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of the tax.

BREAKING DOWN 'Tax Incidence'

The tax incidence represents the distribution of the tax obligations that must be covered by the buyer and seller. The level at which each party participates in covering the obligation shifts based on the associated price elasticity of the product or service in question as well as how the product or service is currently affected by the principles of supply and demand.

Price Elasticity

Price elasticity is a representation on how buyer activity is changed in response to a change in the price of a good or service. In situations where the buyer is likely to continue purchasing a good or service regardless of a price change, the demand is said to be inelastic. When the price of the good or service highly impacts the level of demand, the demand is considered highly elastic.

Examples of fairly inelastic goods or services can include gasoline, electricity and cigarettes. Even if prices change, the level of consumption across the economy remains fairly steady in all of the aforementioned examples. Elastic goods are those whose demand is greatly affected by price. This can include many luxury goods, such as precious metals, as well as large purchases, such as housing, and those with a variety of price points to choose from, such as clothing.

Analysis of Tax Incidence

Tax incidence reveals which group, the consumers or producers, will pay the price of a new tax. For example, the demand for cigarettes is fairly inelastic, which means that despite changes in price, the demand for cigarettes will remain relatively constant. Let's imagine the government decided to impose an increased tax on cigarettes. In this case, the producers may increase the sale price by the full amount of the tax. If consumers still purchased cigarettes in the same amount after the increase in price, it would be said that the tax incidence fell entirely on the buyers.

If a new tax was levied on a more elastic good, such as fine jewelry, the majority of the burden would likely shift to the producer as an increase in price may have a significant impact on the demand for the associated goods.

RELATED TERMS
  1. Elastic

    An economic term referring to the change in behavior that buyers ...
  2. Price Elasticity Of Demand

    A measure of the relationship between a change in the quantity ...
  3. Demand Elasticity

    In economics, the demand elasticity refers to how sensitive the ...
  4. Elasticity

    A measure of a variable's sensitivity to a change in another ...
  5. Total Revenue Test

    A test that approximates the price elasticity of demand by comparing ...
  6. Inelastic

    An economic term used to describe the situation in which the ...
Related Articles
  1. Insights

    What Is Elasticity?

    Elasticity measures the relationship between a good and its price based on consumer demand, consumer income, and its available supply. Learn the basics about it here.
  2. Insights

    Why We Splurge When Times Are Good

    The concept of elasticity of demand is part of every purchase you make. Find out how it works.
  3. Investing

    Product Demand Elasticity

    Demand elasticity is the ultimate measure of how consumer shopping patterns will change with economic conditions.
  4. Investing

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  5. Insights

    What Does Inelastic Mean?

    The supply and demand for an inelastic good or service is not drastically affected when its price changes.
  6. Insights

    What Does Inferior Good Mean?

    The term “inferior good” does not describe a lack of quality, but rather, is an economic term used when discussing elasticity of demand for a good.
  7. Taxes

    "Temporary" Taxes That Stuck

    Taxpayers should be wary when a new "temporary tax" is introduced. Sometimes these temporary taxes are anything but.
  8. Taxes

    Do Tax Cuts Stimulate The Economy?

    Learn the logic behind the belief that reducing government income benefits everyone.
  9. Taxes

    Could The Fair Tax Movement Ever Replace The IRS?

    Although many taxpayers would love to see the IRS abolished, only a handful of thinkers have come up with any sort of viable replacement plan. The Fair Tax is one such idea that has continued ...
  10. Insights

    Explaining Quantity Demanded

    Quantity demanded describes the total amount of goods or services that consumers demand at any given point in time.
RELATED FAQS
  1. Under what circumstances might price elasticity significantly change?

    Discover under what circumstances price elasticity of demand might change and why it is such an important economic concept ... Read Answer >>
  2. How many years can structural unemployment last?

    Understand the two different types of price elasticities, and learn how each one affects the stock purchasing decision of ... Read Answer >>
  3. What is the difference between price inelasticity and inelasticity of demand?

    Learn how supply, demand and pricing are interrelated by studying the concepts used by economists to measure pricing fluctuations. Read Answer >>
  4. How does price elasticity change in relation to supply and demand?

    Learn about how variations in price elasticity affect the supply and demand curves and what factors cause differences in ... Read Answer >>
  5. What are some examples of demand elasticity other than price elasticity of demand?

    Learn about income elasticity of demand and cross elasticity of demand and how to interpret these two measures of demand ... Read Answer >>
  6. How do you quantify price elasticity?

    Learn how to calculate the coefficient for price elasticity, enabling you to approximate how sensitive supply and demand ... Read Answer >>
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  3. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  4. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  5. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  6. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
Trading Center