Tax Incidence

The incidence of a tax is the distribution among taxpayers of that particular tax's economic burden (i.e., the sacrifice of taxpayer utility or welfare). Tax incidence ignores distribution of any benefits received from government expenditures. Tax incidence, tax burden, and tax shifting are closely related notions. Statutory incidence is the initial distribution among taxpayers of a legal obligation to remit tax receipts to the government. Economic incidence is the final burden of that particular tax on the distribution of economic [Page 2060]welfare in society. The difference between initial incidence and final incidence is tax shifting.

For example, the government may levy a tax on gasoline sales, typically as so much per gallon. Initially, this tax falls on the retail seller of gasoline, who is responsible for remitting tax receipts. The retail seller commonly passes this tax fully to the purchaser of gasoline, who bears the final burden. The government intends that the final user of gasoline bear the economic incidence of the tax, and uses the retail seller as a tax collector.

Tax analysis dates back to the French Physiocrats, who immediately preceded Adam Smith's The Wealth of Nations of 1776. Economists study incidence and shifting using tools of partial equilibrium analysis and general equilibrium analysis. Tax incidence concerns fairness or justice of impact of taxes. Equal sacrifice theory argues that each taxpayer should make the same sacrifice of utility or welfare. There are three competing principles of equal sacrifice. Absolute equal sacrifice argues that each taxpayer should bear the same degree of burden. Proportional equal sacrifice argues that each taxpayer should sacrifice the same proportion of welfare. Marginal equal sacrifice argues that each taxpayer should give up the same utility from the last (i.e., marginal) dollar of income or wealth yielded to government.

It is typical to divide taxpayers into incidence groups by income or wealth to measure the degree of progressivity or regressivity. Taxes levied on an ability to pay principle can be classified as regressive, neutral, or progressive. A regressive tax places a higher burden on taxpayers of lesser means. A progressive tax places a higher burden on taxpayers of greater means. A proportional tax with an exemption for taxpayers of low income or wealth exhibits some degree of progressivity. The personal income tax is typically levied using graduated rates rising with the taxpayer's income; and an exemption can be applied for taxpayers of low income.

The burden or sacrifice of a tax, whether levied on the ability to pay principle or the benefit principle of taxation, can be measured as the money amount of tax receipts collected. All taxes other than the poll (i.e., head or capitation) tax exhibit some excess burden, defined as an economic burden greater than those receipts. All other taxes destroy more economic value than the government collects, because taxpayers change their economic behavior in response to the taxation. An excess burden of a tax is a form of deadweight loss of consumer welfare. Only the poll tax cannot be shifted.

The concepts of incidence and economic burden can be applied more broadly than to taxes. Any effect, such as injuries or illnesses, may be distributed unevenly and generate economic burden. Tariffs, monopolies, and theft can be treated as taxes on consumer welfare.

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