=~ | Impact, Shifting and Incidence of T: The traditional concept of shifting and incidence of tax is more popularly associated with the classical theorist, E.R.A. Seligman.! According to him, answer to the following three questions relating to a tax will give us the meaning of the terms impact, shifting and incidence. (a) Who bears the money burden of tax in the first instance ? (b) Is it possible to transfer this money burden of tax to some one else ? (€) Who ultimately bears the money burden of tax ? It is clear from the above that the person who bears the burden of tax in the first instance need not be the person to ultimately bear it. He may transfer the burden. He may not, however, be able to transfer the money burden of tax completely to some one else and he may have to bear a part of the burden. Thus, there are three distinct situations in the process of taxation. Impact of the tax refers to the point of original assessment. Hence, impact is on that person who pays the tax in the first instance. It is the immediate money burden of tax. Thus, when a tax is imposed, its impact is on that Person who bears the immediate money burden of it. The person need not, however, continue to bear this money burden. He will try to transfer this burden to some one else, i.e., he will try to shift the tax. If he is able to transfer the burden to some one else, shifting of tax has taken place. Thus, shifting is the process of transferring money burden of tax. Shifting ends in incidence. Incidence is the ultimate money burden of tax. Hence, incidence of tax lies on that person who is the ultimate bearer of the tax burden. Thus, if the original tax payer is unable to shift the burden of the tax at all, the impact as well as incidence will be on him. If, on the other hand, he is able to transfer the money burden of tax, i.e., if he has succeeded in shifting the tax to some one else, say, Mr. X, the incidence of tax will be said to have moved from him to Mr. X who becomes the ultimate bearer of the tax burden. Suppose, for example, an excise tax is levied on cloth and the tax authority collects it from the manufacturer of cloth. Hence the impact of tax is on the manufacturer. If he is now able to transfer the money burden to the whole-seller by raising the price to the extent of tax, tax shifting has taken place. The whole-seller may again be able to shift this money burden to the retailer and the retailer may pass on the burden to the consumer through a continued process of shifting. If the consumer has no more 1. E.RA. Seligman-"The Shifting and Incidence of Taxation,” page 202. Scanned with CamScannerIncidence Theories and Price-Output Effect 251 Possibility of shifting the tax, he becomes the ultimate bearer of the money ae ict tax and, hence, incidence will lie on him. If at the retail level, on the other hand, be retailer succeeds in shifting only half the tax burden to ultimate consumers and has 2 bear the rest half by himself, then fifty percent of the tax incidence will be on a and fifty percent on the retailer, ie, the incidence will be equally shared between the buyers and the seller. xeeceeeeececerereceerrerprrrrrrn Scanned with CamScannerq When a tax is imposed, the original tax payer tries to transfer its money burden to some one else. This he will do by changing the price of the commodity taxed. If he succeeds in passing the money burden of tax on to the buyer of the product by raising its price, he has shifted the tax forward and the incidence has moved to the buyer, Shifting of the tax may be backward also. When the seller of the product taxed fails to raise the price and is unable to shift the tax forward, either he himself will absorb it or he will try to shift it backward to the factors of production like labour or capital. If he has to absorb the tax by himself, the tax will be an element of cost of production. In such a case, the cost of production will be increased by the amount of the tax. Now, if he is able to shift this money burden of the tax to the owner of a factor of production, say, labour, through wage cut, the tax has been shifted backward to the labour factor. In such a case, cost of production will remain unchanged and the incidence of tax will move to a factor of production. If taxes are unable to be shifted fully, they may be partially shifted forward or partially shifted backward. I'a part ofthe tax is shifted to the buyer of the product taxed, Tt is a partial forward shifting. In such cases, the increase in the price is by less than the full amount of tax. If, on the other hand, the seller of the product is able to shift a part of the tax backward to the owners of factors of production, it is a partial backward shifting and the remuneration of production factor will fall by less than the amount of tax. If we want now to identify the linkage between nature of tax shifting and the nature of change in price, we have to ascertain whether the tax is shifted from the seller to buyer or from the buyer to seller. If it is from the seller to buyer, the price is changed upward and it is the case of forward shifting. A tax on sugar, shifted forwa the buyer of sugar through increased price is an example. If, however the tax is shifte: the buyer to the seller, it is a backward shifting made possible by changing th downward. If, for example, the seller of sugar can shift the tax backward by reducing the wage of labour, he has done it as the buyer of labour. Here the price of labour on which the tax is shifted has been reduced. Thus, forward shifting occurs through raising of prices while backward shifting results in loweing of prices. Another way of distinguishing backward shifting from the seller's inability to shift the tax forward is to ascertain whether the tax was originally imposed on the seller or on the buyer. The seller of a product is, however, buyer of labour. Take the case of unemployment compensation tax on employers for creating a reserve fund to finance unemployment benefit to the unemployed. In such a case, one need not expect that incidence of this tax will be upon the employer himself. Some part of the tax will be shifted forward to the buyers of the employer's product. Partial forward shifting of tax in this case is from seller to the buyer of the product through raising of its price. It is important to note here that the product with reference to which seller and buyer is identified is not itself taxed. But the person who has paid the unemployment tax is @ seller in the process of forward shifting. On the other hand, larger part of the tax will most usually be shifted backward to the employee in the form of lower wages than would otherwise be paid. This partial backward shifting is from buyer to seller of the Scanned with CamScanner(1) Shifting under situations of demand elasticity. With given elasticity of supp}, shifting of tax through the price vehicle will be different under different situations of demand elasticity. The seller of the product will try to shift the tax on to the buyer through raising of its price. He will completely fail to shift the tax if the price of the product cannot be at all increased. This will happen when the demand Tor the productis perfectly elastic, because he cannot sell the goods even if he slightly raises the price. On the“other hand, he will be able to shift the whole amount of tax to the buyer if the demand for the product is completely inelastic, in which case the sale of the commodity will ot fall at all even if the price is icreased by the full amount of the tax. Both of these are however, extreme situations. The more normal situations lie in between the two. To what extent will the seller be able to shift the tax to buyer, ie., by what amount of the tax he will be able to raise the price of product will depend upon whether the demand is more elastic or less elastic. The following figures will clarify the situations. ¥ Y D w 1 S & Pi s | ° @ x QUANTITY ——> QUANTITY ——> Fig, 14.1. incidence Under Fig. 142. Incidence Under Perfectly inelastic Demand. Perfectly Elastic Demand. In both the figures, we measure quantity of commodity taxed along the horizontal axis and its price along vertical axis. D and S are respectively demand and supply curves. The given supply conditions are shown by S. Before any tax is imposed, the equilibrium quantity of demand is OQ at price PQ. Now, suppose, a tax per unit of commodity equal to the vertical difference between S and S; is imposed. Tax will raise the supply price Si. Since tax per unit of commodity is the same at any level of output, the post-tax supply curve S; will be parallel to the pre-tax supply curve S. Now in figure 14.1., demand curve is perfectly elastic ie., horizontal straight line. Hence, by reduction of output also price can not be raised but will remain the same. In spite of the tax, therefore, the post-tax equilibrium price, P; Q; has remained the same as pre-tax price. It means that shifting of money burden of the tax has not been possible. Thus, the incidence of tax under perfectly elastic demand will remain on the seller of the product_ - The output has, however, been reduced to O Qi. Out of = price P; Qi which the buyer will pay, the seller will get only QiC, while the tax CP, will go to the government. In figure 14.2, on the other hand, the demand curve moun! QD Scanned with CamScannerpeidance TheOFes and Price-Output tect 255 fectly inelastic in whi : is ead THE post-tax prise incon raising of the price does not at all reduce the The quantity sold is not reduced at 1Q which rises by the full amount of the tax, PP. Mie the original price PO, ‘teyall But femaino the same and the seller continues (0 meses uly on the buyer. ‘Therefore, 2 coma cegmletely shifted and, hence, is i demand is completely elastic, wh it wal 2 not at all be shifted when demand is completely inelastic, ** * Will be fully shifted to the. fowever, if the demand is nei — Fiealy elastic in between thence! Perfectly elastic nor perfectly inelastic but remain tha the buyer. The incidence of roe eeme®> incidence will be shared between the seller the more elastic the demand for aaa = the seller and smaller on the buyer, more inelastic, tax will be largely oon is. On the other hand, if the demand is absorb a small part of tax. The inched (to the consumer and, hence, the seller will jess on the seller. In figure 143, D is more elastic | therefore, be more on the consumer and I demand curve than Dj. The pre-tax tax supply curves are given by S and S ae BBP more elastic: the prinn yo fespectively In the frst case where demand (ehown Y —— PRICE Fig. 14.3, Incidence sharing under different demand elasticities. In the other case of less elastic demand (shown by D,), price increases by a much larger amount P; M. This part of the tax is, therefore, shifted to the buyer, while the remaining portion MN is absorbed by the seller. Thus, larger part of the incidence is on buyer and smaller part on seller. With still lesser elastic demand curves, the relative share of incidence on the buyer will be increasingly larger. Thus P3 M > P; K while MN < KL, Hence, we can express the tendency in another way : the larger the elasticity of demand, larger will be the tax incidence on seller and smaller on the buyer, other things remaining the same. x situations of supply elasticity. To examine the influence of oy Sea aeelat fax, we have to assume a given situation of demand elasticity. The supply of a commodity may be either completely elastic or completely inelastic or may have different degrees of elasticity in between the two extremes. Figure 14.4. Tepresents a perfectly elastic supply situation where D is the given demand curve while Sand S; are vespectively the pre- tax and post-tax supply curves. The imposition of tex PiM per unit of the commodity reduces the supply from OQ to O Q; and raises the price from’OP to 0,Pi, ‘Thus, the price rises by the full amount of the tax. The tax is fully shifted to the consumer. Scanned with CamScanner =Incidence Theories and Prce-Outpt Eng, 7 y 1S Py ne, a 8 $1 whe ig a E © . Ss o | "| ‘ ° a; @ x ° @ x ——> Quantity Fig. 14.4 Incidence under perfectly elastic supply. Fig. 14.5. Incidence under perfectly inelastic supply. But, unlike this, when the supply is completely inelastic as shown in figure 14.5, the imposition of tax changes neither price nor supply of commodity. The post-tax supply curve will necessarily remain unchanged ie., QS, because the supply of the commodity is fixed at OQ. Since there will be no other point of demand-supply equality than at P, the price will remain the same and the tax on commodity will have to be fully absorbed by the seller. Therefore, the incidence of tax will be fully on the buyer when supply of the commodity taxed is perfectly elastic, while the incidence will be wholly on the seller when supply is perfectly inelastic. However, with varying degrees of elasticity of supply in between these two above extremes, incidence of tax will be shared between the seller and the buyer of the commodity. This is shown in figure 14.6. Incidence of the same amount of TT; is differently shared under different elasticities of supply. Two different situations are shown by the more elastic supply curve TS and less elastic supply curve T So. With TS supply schedule, tax raises the price by PiM. Hence, larger part of the tax is shifted to buyer while a smaller part is absorbed by the seller. The opposite is, however, the case with less elastic supply curve T Sp where the same tax per unit of commodity can raise the price by only P3N which is much less than PM. Hence, only P5N is shifted to the buyer and the larger part of the tax ie., PN has to Scanned with CamScanner