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Tax Incidence: Definition & Overview

Updated: April 19, 2023

A tax incidence is essentially the tax burden that a partyā€”a person or a companyā€” carries even though they aren’t the ones paying the tax.

An economic concept known as “tax incidence” explains whoĀ  bears the burden of a tax in the end, as opposed to on whom the tax is initially assessed. To put it another way, even if someone doesn’t actually pay the tax, they could nonetheless experience its consequences, such as paying higher costs for goods and services.

If you’re active in policy making, understanding the concept of the tax incidence can assist you in anticipating the full effects of various taxes.

Read on as we take a closer look at exactly what tax incidence is, how it works, the different types of tax incidence, and what the impact is.

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    KEY TAKEAWAYS

    • A tax incidence, or an incidence of tax, is a term used to describe how certain tax burdens will affect different economic groups.
    • Tax incidences are common between a buyer and a seller, a producer and a consumer, and even with supply and demand.
    • A tax incidence describes who is going to bear the cost of a new tax.

    What Is Tax Incidence? 

    A tax incidence, or an incidence of tax, is a term thatā€™s used to better understand how the division of tax occurs between different types of stakeholders. For example, this could be between a producer and a consumer or a buyer and a seller. 

    Plus, a tax incidence can also happen in economics with the elasticity of supply and demand. If the supply becomes more elastic than the demand is, the bigger tax burden is going to fall on a buyer. On the other side, if demand becomes more elastic than the supply, itā€™s the producers that are going to take on the tax burden and extra costs. Elasticity refers to a change in consumer behavior in response to price changes of goods and services.

    To keep things as simple as possible, a tax incidence or tax burden is how a particular tax will affect the distribution of economic welfare.

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    How Does Tax Incidence Work? 

    Tax incidence measures the distribution of certain tax obligations between buyers and sellers, or manufacturers and their customers. Which group is ultimately going to bear the burden of the tax depends on the elasticity of the specific product or service. 

    If a demand in the market for a certain good is not elastic (doesnā€™t go up or down with price changes), the tax burden will be carried by the consumer. A good example is the pharmaceutical industry.

    What Are the Types of Tax Incidence? 

    There can be two primary types of tax incidence. These are:

    • Economic incidence ā€” This can also be referred to as the final incidence, and itā€™s the final burden of a particular tax.
    • Statutory incidence ā€” This is the incidence that occurs when it comes to corporate income tax. It explains that the tax burden falls on corporate executives, meaning they are responsible for remitting taxes to the government. 

    What Is the Impact of Tax Incidence? 

    It all depends on which side of the tax burden you fall on. For example, if there is a significant fluctuation in the supply and demand for a product or service, either the buyer or the seller will take on the tax burden.Ā 

    If the market continues to fluctuate or fluctuates drastically, it can have a big impact on whichĀ  party feels the economic burden the most. Sellers might have a difficult time generating revenue for the product or service they sell if they have to take on the cost of the tax.

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    What Does Tax Incidence Determine? 

    Tax incidence can determine a few different elements. Mainly, it helps measure the true cost of new taxes levied by the government. The difference between the initial incidence and the final incidence may indicate tax shifting. Tax shifting occurs when a business shifts the cost of the tax forward to the final consumer (higher price of the goods), or backward to the business stakeholders (lower employee wages).

    For example, the government might decide to levy a new tax on gasoline. The burden will first fall on the seller of the gasoline since theyā€™re responsible for remitting taxes. Ultimately, the statutory incidence stays on the seller. 

    However, the seller will then pass the cost of this new tax to the buyer by increasing the price of gasoline.

    Summary 

    Tax incidence measures how the burden of tax is shared between various participants. This could be between a buyer and a seller or a producer and a consumer. Tax incidence may also occur due to fluctuations and variations in the supply and demand of a product or service. 

    There are two primary types of tax incidence. These are economic incidence and statutory incidence.

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    Sandra Habiger is a Chartered Professional Accountant with a Bachelorā€™s Degree in Business Administration from the University of Washington. Sandraā€™s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

    Sandra Habinger headshot

    Written by Sandra Habiger, CPA

    Sandra Habiger is a Chartered Professional Accountant with a Bachelorā€™s Degree in Business Administration from the University of Washington. Sandraā€™s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

    FAQs About Tax Incidence

    What Is the Tax Incidence on Consumers?

    Tax incidence describes who is going to take on the burden of paying a new tax. The best example involving consumers are gasoline prices. The seller will pass the tax on to the buyer through a price increase.

    What Is the Difference Between Tax Burden and Tax Incidence?

    A tax incidence measures the distribution of a new tax burden between different economic groups. A tax burden is the amount of tax directly paid by an individual person, country, or company to the government based on their income levels.

    Can Tax Burden be Shifted?

    Tax shifting happens when a seller shifts the cost of a new tax forward to the consumer or backward to the business.

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