Government generally collect taxes to generate revenue and question arise here is that after imposition of taxation, which group will bear the tax burden. After implementation of tax, there would be the division of tax burden between byres and sellers which is known as tax incidence. Tax incidence is linked to the price elasticity of demand and supply. If supply is more elastic than demand then the tax burden falls upon the buyers and when the demand is more elastic than supply then the producers will bear the cost of the tax.
Tax incidence is basically the analysis of the effect of taxation on the distribution of economic welfare. Tax incidence expose that which group either consumer or producer is going to pay the price of new tax and it falls mostly on the group that has the inelastic price quantity or respond least to the price. Tax incidence or the tax burden does not depend on that where the revenue is collected but it depends upon the elasticity of demand and supply. The purpose of this review on the literature is that to analyze the effect of particular tax on the distribution of economic welfare. Section 2 is related to the literature review and section 3 is related to the conclusion.
2. Review of Literature
2.1 The incidence of sin taxes:
Kotakorpi (2008) has examined the incidence of taxation on sin commodities. Sin commodities are those commodities whose current consumption causes utility cost in the future. Consumers are considered to be time inconsistent or having too much consumption of unhealthy goods. Sin taxes means taxes on unhealthy commodities. In the context of monetary cost sin taxes would lead to influence the individual’s utility. Increase in the consumption of sin commodities would lead to a higher monetary cost or higher utility benefit from self controlling. The author has analyzed the welfare effect of the sin taxes and the welfare effect of sin taxes depends upon the elasticity of demand. The individuals with less income group having higher elasticity of demand as compare to the high income group. There is possibility of progressive taxation as the benefit is high for the less income group. He has measure the incidence on individual utility through the overall impact of the tax.
Sin taxes would lead to increase the welfare if the demand for the unhealthy good is more elastic. For the case of poor demand is more elastic so the burden of sin taxes falls least on the poor as compare to the rich. It’s not necessary that taxation always hurts low income group but can be fair for the poor. The welfare of the economy would increases in case of sin taxes. 2.2 The incidence of tax on pure rent in a small open economy: Petrucci (2006) has investigate the effects of a land tax on capital structure and foreign investment in a life cycle small open economy with the assumption that labor supply is take as endogenous. Land is an as asset which is used as an input for the production.
Tax on land means the higher would be the capital stock. The land tax leads to reduce the price of land but crowds out investment, consumption and welfare of nationals would increase. The consequences of land taxation depends upon that how government adopted the tax transfer program. Labor supply and domestic output reduced by land taxation, while the wealth and national income are increased. If land taxation were used to finance the un-productive government expenditure then the effects of taxation on the capital stock and aggregate wealth would be neutral. The main assumption of this article is the endogenous labor supply regarding the long run incidence of taxes. The final effects of land taxation on economic growth and wealth formation depend upon that the government tax transfer program. When tax revenues are distributed as lump-sum payments then the land taxation increases consumption and stimulate wealth but leads to reduce the capital stock.
2.3 Tax incidence in bargaining:
Chae (2002) has investigates two-person bargaining model where one party is taxed and the other is non-taxed party who shares the burden of taxes. Sufficient condition is that tax party would entirely bears the tax burden are given and non-tax party would actually to benefit from taxation is given. In a competitive market, buyers and sellers share the tax burden and the larger burden falling on the party that has lower price elasticity. In a bargaining model, if the gross revenue of the tax party does not change then the taxation does not affect the other party. Thus the tax burden will falls completely on tax party. If the tax party is risk neutral and has zero opportunity cost then the burden of taxation falls completely on the tax party. If the tax party is risk averse with the constant relative risk aversion, then the tax burden is shared by the non-tax party as initial wealth is also positive. The results show here that a risk loving party loses more form taxation than the risk averse party.
In general, a bargaining party that is less risk averse has more bargaining power but the party with more bargaining power can also be more at risk to taxation. 2.4 The general equilibrium incidence of environmental taxes: Fullertton (2007) used a simple general equilibrium with pollution and has found the incidence of pollution tax on prices of outputs and on the returns to inputs. When both sectors are equally capital intensive and capital is a better substitute for pollution then is labor. Then return to capital would rise comparative to wage. These results provide evidence that the substitutability of capital and labor has very important consequences for environmental policy. The results show that a 10% increase in the pollution tax rate reduces pollution from 2% to 10%.
The model in this paper provides theoretical analysis of the incidence and distributional effects of environmental policy. It shows that how differential substitution between factors greatly effect the burdens of a pollution tax. Environmental taxation has mostly focused on efficiency effects. This paper provides theoretical general equilibrium model of tax incidence of an environmental tax that allows for general forms of substitution among inputs of labor, capital and pollution. Pollution is modeled as an input along with capital and labor. Environmental policies can have important effects on firms’ demands for capital and labor inputs, which can impact the returns to owners of capital and labor in general equilibrium.
2.5 The tax system incidence on unemployment: A country specific analysis for the OECD economies: Ramon et.al (2008) examines the incidence of different tax structure on unemployment in OECD countries through wage bargaining model. The first important result from the analysis is that fiscal wedge does not play an important role in explaining unemployment. The more the payroll taxes are influenced towards the employees, the higher would be the unemployment. This is due to the higher elasticity of taxes impose on workers so that tax components affect unemployment even when the overall fiscal wedge remains unchanged.
As unemployment determination is considered, supply side determinants (productivity growth) positively related to the unemployment determination but negatively related with demand side determinants (inflation). This suggests that high situation of unemployment persistence may tend to require more structural reforms. If changes in the tax composition that leave the overall amount of revenues unchanged are harmless in terms of unemployment persistence then new possibilities for policy makers can be considered.
2.6 Tax and subsidy incidence equivalence theories: experimental evidence from competitive markets: Ruffle (2005) stated that tax burden does not depend upon that where revenue is collected but the division of tax burden between buyers and sellers only depend upon the elasticity of supply and demand. The theory of tax incidence equivalence is strongly related to the market formation and also enlarges to the subsidies. The benefit of the subsidy is not related to the one that who is in fact getting the subsidy.
Basically, government should charge tax to decrease the agreement costs and it should not to leave the restrictive producers at disadvantages. In the competitive equilibrium market, particular shifts of supply and demand curves are considered to analyze the tax and subsidy equivalence theorems. Both the smaller no of markets and sufficiently large no of markets can trade profitably at the competitive price. The results propose that the discussion topic is that who is paying the tax or receiving the subsidy should pay attention on formation that at what degree market is under the competition level. And if the market is competitive then the tax should be manage in a manner that reduces the expenditure cost.
2.7 Tax incidence under oligopoly: a comparison of policy approaches: Hamilton (1999) examined the tax incidence under the oligopolistic market structure. Basically two forms of commodity taxation considered are the unit (or specific) tax and sales (or ad valorem) tax. The author has incorporated the shift parameters in a generalized tax schedule to analyze the incidence of taxation under oligopoly. Greater industry output and increased output per firm is associated with output elastic schedule.
If there is a case of free entry in oligopoly then there would be the larger reduction in industry fix cost relative to the tax schedule that is less responsive to the equilibrium level of output. Taxation under oligopoly, benefit would be increased with revenue neutral reforms to relatively output elastic tax plan. The results of other studies show that with specific or ad valorem taxation leads to efficiency loss in oligopolistic industries with a fix number of firms. Degressive taxes with both specific tax and ad volarem tax leads to efficiency gain, when the tax output is elastic enough.
2.8 The incidence of income tax on wages and labour supply:
Bingley and lanot (2002) has analyzed the determination of equilibrium and labor supply in the presence of income taxes. They found the strong evidence of fractional shifting of income tax from worker to employer. As tax is not fully shifted if the income tax is incident on equilibrium wage. There is not shifting of burden of taxation as labor supply response to wages is measured. And the labor supply elasticity with respect to wage is very small after income taxation. Higher income tax leads to a higher employment. In the article, the author showed the effect of income tax on gross wages and labor supply wage elasticity.
The incidence of taxation on gross earnings is a mix of labor supply and gross wage responses. In this model the author has chosen the Denmark country. In Denmark, income tax varies regionally as workers pay tax according to where they live rather than where they work. The result shows that the, in Denmark, gross earnings bear less than the full burden of labor taxation and gross wages bear proportionately more of that tax burden. The results shows, by ignoring the labor supply response to a tax change may lead to a wrong conclusion that the tax is fully incident on equilibrium earnings.
2.9 The incidence of personal income taxation: evidence from the tax reform act of 1986: D. kubik (2004) examined in this paper about the short run incidence of personal income taxation in US by analyzing that how wage structure shifted after the tax reform act of 1986. In this analyses pre tax wages and income of workers are endogenously determined through tax policy. Workers of an economy with different skills, the pre tax wage of each skill depend upon the quantity of labor supplied. Basically, the purpose of the paper is that whether changes in personal income tax affect the US wage formation through the evidence from the tax reform act of 1986. Firstly, the author has tested that how marginal tax rate of the median worker in each occupation changed due to the tax reform and then tested the wages of workers in each occupation before and after 1986.
Personal income taxation changes through the tax reform act of 1986 have affected the wage distribution and results shows that the legislation has lowered the marginal tax rate of high income individuals but low income individuals relatively unaffected. If the training and potential earnings of the people are quite similar then the tax reform act of 1986 will affected the people in the same way. High skill workers in a profession earns high incomes leads to a sharp decline in marginal tax rate but on the other hand low income individuals faced minor changes in marginal tax rate. The result depends on the assumption that labor supply decisions are affected by the marginal tax rate. Labor supply decision changes as individuals change their work hour decision or can cause a worker to drop the profession. Wage rate were affected by the shifts of workers supply in the labor market due to the tax reform 1986.
2.10 Tax incidence when individuals are time-inconsistent: the case of cigarette excise tax: Gruber and Koszegi (2004) stated that lower income groups consume much of the unhealthy or sin commodities to which excise tax is imposed in a greater proportion as compare to the higher income level. There is negative relationship between income and part of income which is spending on sin commodities. For example the imposition of tax on gasoline would be fall on the low income level and their utilities would be affected after increase in taxes.
In this model consumers are considered to be time inconsistent in their consumption decision. In the model author has considered the smoking decision which is more appropriate in time inconsistent structure. The basic purpose of the incidence analysis is to determine that who is going to bear the tax through different tax policies and the adequate measure for this analysis is utility. Bad commodities such as smoking have been under discussion among policy makers and academics. The important point here is that tax on harmful addictive commodities is equal to the external cost and such taxes are highly regressive.
Government basically collects taxes to generate revenues the important thing is that through which procedure it is being collected and who is going to bear the larger part of tax. After implementation of tax what would be the effect of tax on the welfare of the economy. Redistribution of income can be increased through taxation. Employment can be increased through labor income taxation. Welfare of the economy can be increased through sin taxes. Taxation on the unhealthy commodities leads to increase the welfare of the economy.
Bingley, Paul and Lanot, Gauthier (2002), ” The incidence of income tax on wages and labour supply”, “Journal of public econmics”, vol: 83, page 173-194
Chae, Suchan (2002), “Tax incidence with bargaining”, “Economics Letters”. Vol: 77, page 199-204
Fullerton, Don and Heutel, Garth “The general equilibrium incidence of environmental taxes”, “journal of public economics”, vol: 91, page 571-591
García, José Ramón and Sala Hector, (2008), “The tax system incidence on unemployment: A country-specific analysis for the OECD economies”, “Economic Modelling”
Gruber, Jonathan and Koszegi, Botond (2004), “Tax incidence when individuals are time-inconsistent: the case of cigarette excise taxes”,” Journal of public economics”, vol: 88, page 1959-1987
Hamilton, Stephen F. (1999), “Tax incidence under oligopoly: a comparison of policy approaches”, “Journal of public economics”, vol: 71, page 233-245
Kotakorpi, Kaisa (2008), “The incidence of sin taxes”, “Economics Letters” vol: 98, page 95-99
Kubik, D. Jeffrey (2004), “The incidence of personal income taxation: evidence from the tax reform act of 1986”, “Journal of public economics”,
vol: 88, page 1567-1588
Petrucci, Alberto (2006), “The incidence of a tax on pure rent in a small open economy”, “Journal of public economics”, vol: 90, page 921-933
Ruffle J.Bradley (2005), “Tax and subsidy incidence equivalence theories: experimental evidence from competitive markets”, “Journal of public economics”, vol: 89, page 1519-1542
University/College: University of Chicago
Type of paper: Thesis/Dissertation Chapter
Date: 28 September 2016
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