Tax incidence is the question of how the burden of a tax is distributed between different parties to the transactions that are being taxed, and perhaps even other parties involved in related transactions. The concept of tax incidence looks beyond who has the immediate responsibility of paying the tax money, to the secondary effects where related prices and terms of transactions are altered to reach a new equilibrium in a world with the tax.
Incidence of government surplus versus deadweight loss
The introduction of taxes generally has two effects:
- There is a deadweight loss due to taxation, because some transactions that would have occurred without the tax get priced out due to the tax. The incidence of this deadweight loss is shared between the parties that end up not doing the transaction any more. This deadweight loss is typically captured geometrically using a Harberger triangle.
- Some of the surplus originally captured by the parties involved in the transaction gets shifted to the government (taxing authority).
Questions of incidence can be asked for both types of effects.
Relation with price-elasticity of demand and supply
As a general rule, the more price-inelastic side bears more of the tax burden, both in terms of deadweight loss and in terms of the portion of surplus captured to the taxing authority.
- Effect of sales tax on social surplus, which builds on the analysis of effect of sales tax on market price and quantity traded, discusses the tax incidence of a sales tax on producers and consumers.