03 September 2012

Day 86: Who Really Pays the Taxes?

Governments spend lots of time specifying and developing the ways in which taxes are raised and who should carry the heaviest or the lightest tax burdens. However, governments can really only specify who hands over the tax to the government - and this is called the statutory or legal incidence of the different taxes.

But a distinction must be made between who hands over the money to the authorities (statutory/legal incidence of taxes) and who bears the actual burden of the tax (this is called the effective incidence of taxes).

Taking a company as an example. It is often forgotten that when a company is taxed, it is the individuals behind the company who bear the burden of the tax. In the case of a company, we can identify 3 groups of individuals:
1. The owners and shareholders of the company
2. The employees of the company
3. The customers of the company

Whenever a company is taxed at a higher rate, it will attempt to pass on the burden of the higher tax to: its customers - trying as much as possible to protect the owners, shareholders and employees of the company.

Having to pay a higher tax to be able to operate as a company in essence means that the company is incurring higher costs to supply the particular good or service the company supplies. If the cost of production goes up - we know that the price of the product will go up. So, even though it is a company that is being taxed, it is the consumers who end up paying the higher price - and thus, who bear the tax burden.

The extent to which companies can pass on their taxes will depend on the price elasticity of the good or service they are providing. If the demand of the product does not go down by much with an increase in price - then most or all the burden of the tax will be passed on to the clients/customers. If the demand, however, is very sensitive to a change in price - then the company will only be able to afford to pass down the tax to the customers to a limited extent.

So - even though the government uses taxation as a way to redistribute resources in a more fair or equitable way - the economic system itself negates these efforts to a large extent, rendering them ineffective - and thus, the government, using this tool, fails to establish an economic situation where all resources are fairly distributed amongst all.


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