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Tax Incidence: Definition & Overview

Updated: November 25, 2022

A tax incidence is essentially the weight that a party—a person or a company—endures even though they aren’t the ones who are really paying the tax.
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An economic concept known as “tax incidence” explains who eventually bears the burden of a tax, in addition to the fees themselves. To put it another way, even if someone doesn’t actually pay a tax, they could nonetheless experience its repercussions, such as paying higher costs.

If you’re active in policy making, comprehending tax incidence can assist you in better comprehending 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 or tax, is a term used to describe how certain tax burdens will be established.
    • 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 take on the burden of a new tax. 

    What Is Tax Incidence? 

    A tax incidence, or an incidence of tax, is a term that’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 with 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 flip side, when demand becomes more elastic than the supply, it’s the producers that are going to take on the tax burden and extra costs. 

    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? 

    Buyers and sellers, for example, will use a tax incidence to help determine the distribution of certain tax obligations. How much one or the other has to pay in tax, or their overall obligation, is going to depend on the elasticity of the specific product or service. 

    Plus, it also considers the factors of supply and demand. A tax incidence will essentially outline who is going to pay the price of a new tax. For example, there are regular changes in cost when it comes to prescription drugs and their demand. Yet, the market stays steady. 

    What Are the Types of Tax Incidence? 

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

    • Economic incidence — This can also get referred to as the final incidence, and it’s the final burden of a particular tax.
    • Statutory incidence — This is the incidence that occurs when it comes to corporate income tax. It describes that this burden falls on corporate executives. 

    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. 

    If the market continues to fluctuate or fluctuates drastically, it can have a big impact on whichever party takes on the economic burden most. Sellers might have a difficult time generating revenue for the product or service they sell if they have to take on the division of the tax payment long-term. 

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    What Does Tax Incidence Determine? 

    Tax incidence can determine a few various elements. But with that said, it helps to measure the true cost of new taxes levied by the government. If there becomes a difference between the initial incidence and the final incidence, this is commonly known as tax shifting. 

    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 they’re responsible for remitting tax receipts. Ultimately, the statutory incidence stays on the seller. 

    However, the seller will then reflect the new tax on the price of the gasoline when the buyer makes a purchase. This essentially passes the tax on to the buyer. All in all, a tax incidence will determine who carries the burden of a new tax.

    Summary 

    Tax incidence has to do with the way in which the burden of tax is shared between various participants. This could be between a buyer and a seller or a producer and a consumer. As well, fluctuations and variations in the supply and demand of a product or service will allow for tax incidence to occur. 

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

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    FAQs About Tax Incidence

    What Is the Tax Incidence on Consumers?

    Tax incidence describes and reveals who is going to take on the burden of paying a new tax. The best example for consumers is gasoline prices. The seller will account for the new tax they took on the price of the gasoline when they sell it to the buyer.

    What Is the Difference Between Tax Burden and Tax Incidence?

    A tax incidence breaks down how a buyer and seller are going to divide a new tax burden. A tax burden is the amount of tax that’s paid by an individual person, country, or company, and it’s based on income.

    Can Incidence of Tax Get Shifted?

    Yes, a tax incidence can get shifted. When there’s a difference between the initial incidence and the final incidence, it can be known as tax shifting.

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