Tax incidence

In economics, the tax incidence measures who actually pays for a tax. Economists distinguish between the entities who ultimately bear the burden of a tax (the real incidence) and those who the tax is originally collected from (the nominal incidence). The tax burden measures the true economic effect of the tax, measured by the difference between real incomes before and after imposing the tax, and taking into account how the tax causes prices to change. For example, if a 10% tax is imposed on sellers of butter, but the market price rises 8% as a result, then 80% of the tax incidence falls on buyers, not sellers.

Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately suffers a loss from, the tax. The key concept of tax incidence is the finding that the tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply.

The concept of tax incidence is used in political science and sociology to analyze the level of resources extracted from each income social stratum in order to describe how the tax burden is distributed among social classes. That allows one to derive some inferences about the progressive nature of the tax system, according to principles of vertical equity.

The theory of tax incidence has a number of practical results. For example, United States Social Security payroll taxes are nominally paid half by the employee and half by the employer. However, economists generally find that workers bear most of the burden of the tax, because the employer passes it on in the form of lower wages. The tax incidence is thus said to fall mainly on the employee.