Implications of a tax wedge Tax wedge

when demand more inelastic supply, consumers bear more of tax. (ex. cigarettes)



when supply more inelastic demand, producers bear more of tax. (ex. beachfront hotels)


tax incidence

there 2 types of tax incidence or tax burden created tax: statutory incidence of tax , economic incidence of tax. typically, general reference tax incidence refers economic incidence of tax.

the statutory incidence of tax falls on party, producers or consumers, has physically send check government in amount of tax. example, if person directly pays or income tax government (with no employer withholding), statutory burden fall on consumers. if tax imposed on producers of gasoline, however, statutory burden fall on producers.

the economic incidence of tax falls on party bears actual cost of tax. put way, economic incidence reflects actual change in individual s or firm s resources due tax. statutory incidence of tax irrelevant economic incidence of tax. in fact, economic incidence determined elasticity of supply , demand. typically, both producers , consumers bear portion of economic incidence of tax, these portions not have equal. party more inelastic (steeper) curve bears more of tax. example, consumers of tobacco products typically bear more of tax on tobacco, because addicted product , consumption not affected price changes (demand inelastic). producers bear more of tax when supply inelastic; example, producers of beachfront hotels bear more of tax on hotels , accept lower prices product, because change in price not have large effect on quantity of beachfront hotels. these examples illustrated graphically (right). economic incidence on consumers equal




p

c


−

p

∗




{\displaystyle p_{c}-p^{*}}

, , incidence on producers equal




p

∗


−

p

s




{\displaystyle p^{*}-p_{s}}

.

full shifting of tax occurs when 1 party in transaction bears of tax burden. when demand inelastic, tax burden shifted onto consumers; when supply inelastic, tax burden shifted onto producers. in long run, however, supply , demand both become more elastic: consumers preferences product can change (cigarette smokers can quit smoking), , suppliers can choose reduce investment in, or leave, market (a hotel chain can decide sell beachfront properties). means economic incidence on consumers , producers can change in long run.