Question

10) Explain the following statement. The burden of a tax is borne by individuals in relationship

to their ability to escape the tax. (Hint: use of equations and especially well explained diagrams

will be helpful in answering the question.)

Answer 1

A tax  is a mandatory financial charge or some other type of levy imposed upon a taxpayer (an individual or other legal entity) by a governmental organization in order to fund various public expenditures. failure to pay, along with evasion of or resistance to taxation, is punishable by law. Taxes consist of direct or indirect taxes and may be paid in money or as its labour equivalent.

Most countries have a tax system in place to pay for public/common/agreed national needs and government functions: some levy a flat percentage rate of taxation on personal annual income, some on a scale based on annual income amounts, and some countries impose almost no taxation at all, or a very low tax rate for a certain area of taxation. Some countries charge a tax both on corporate income and dividends; this is often referred to as double taxation as the individual shareholder(s) receiving this payment from the company will also be levied some tax on that personal income.

Tax burden is the analysis of the effect of a particular tax on the distribution of economic welfare. The introduction of a tax drives a wedge between the price consumers pay and the price producers receive for a product, which typically imposes an economic burden on both producers and consumers.

The theory of tax incidence has a number of practical results. For example, United StatesSocial Security payroll taxes are paid half by the employee and half by the employer. However, some economists think that the worker bears almost the entire burden of the tax because the employer passes the tax on in the form of lower wages. The tax incidence is thus said to fall on the employee.However , it could equally well be argued that in some cases the incidence of the tax falls on the employer. This is because both the price elasticity of demand and price elasticity of supply have an effect on whom the incidence of the tax falls. Price controls such as the minimum wage which sets a price floorand market distortions such as subsidies or welfare payments also complicate the analysis.

GRAPHICAL ANALYSIS

Inelastic supply, elastic demand

Because the producer is perfectly inelastic, they will produce the same quantity no matter the price. Because the consumer is elastic, the consumer is very sensitive to price. A small increase in price leads to a large drop in the quantity demanded. The imposition of the tax causes the market price to increase from P without tax to P with tax and the quantity demanded to fall from Q without tax to Q with tax. Because the consumer is elastic, the quantity change is significant. Because the producer is inelastic, the price doesn't change much. The producer is unable to pass the tax onto the consumer and the tax incidence falls on the producer. In this example, the tax is collected from the producer and the producer bears the tax burden. This is known as back shifting.

Elastic supply, inelastic demand

If, in contrast to the previous example, the consumer is perfectly inelastic, they will demand the same quantity no matter the price. Because the producer is elastic, the producer is very sensitive to price. A small drop in price leads to a large drop in the quantity produced. The imposition of the tax causes the market price to increase from P without tax to P with tax and the quantity demanded to fall from Q without tax to Q with tax. Because the consumer is inelastic, the quantity doesn't change much. Because the consumer is inelastic and the producer is elastic, the price changes dramatically. The change in price is very large. The producer is able to pass (in the short run) almost the entire value of the tax onto the consumer. Even though the tax is being collected from the producer the consumer is bearing the tax burden. The tax incidence is falling on the consumer, known as forward shifting.

Similarly elastic supply and demand

Most markets fall between these two extremes, and ultimately the incidence of tax is shared between producers and consumers in varying proportions. In this example, the consumers pay more than the producers, but not all of the tax. The area paid by consumers is obvious as the change in equilibrium price (between P without tax and P with tax); the remainder, being the difference between the new price and the cost of production at that quantity, is paid by the producers.

KEY TAKEAWAYS

• The true measure of the burden of a tax is the change in people's economic situations as a result of the tax.

• The economic burden of a tax frequently does not rest with the person or business who has the statutory liability for paying the tax to the government.

• Modern advances in economic understanding strongly urge us to dispose of the current income tax structure and replace it with a flat rate tax.

The elasticities of demand and supply tend to be greater in the long run than the short run. It may take some time for people fully to adapt to a tax change. For example, in the short run, a rise in the tax on gasoline may encourage people to drive their existing cars less by taking fewer trips, by car pooling, or by switching to public transportation. Longer-term, people may replace their existing cars with models that offer higher fuel economy or may move closer to their work. The long-run demand for gasoline should be more elastic than the short-run demand.