Impact, Incident and effect of a Tax

Anika Rafah
Lecturer
North South University
 Introduction
• Incidence of tax or tax burden is the analysis of the effect of a
particular tax on the distribution of economic welfare.
• Tax incidence is said to "fall" upon the group that ultimately bears
the burden of, or ultimately has to pay, the tax.
• It is thus the ultimate resting of a tax upon individuals or class who
cannot shift it further.
• A tax may be impose on some person.
• It may be transferred by him to a second person.
• It may be ultimately bear by this second person or transferred to
others by whom it is finally assumed.
 Incidence of Tax

• By incidence of taxation is meant final money burden of a tax

or final resting place of a tax.
• It is the desire of every government that it should secure
justice in taxation, but if it does not know as to who ultimately
bears money burden of a tax or out of whose packet money is
received, it cannot achieve equality in taxation.
• If government knows who pays tax, it can evolve an equitable
tax system.
• It can easily tap important sources of taxation and thus can
collect large amount of money without adversely affecting
economic and social life of the citizens of the country.
 Impact of Tax
• The term impact is used to express the immediate result of or
original imposition of the tax.
• Impact of a tax is on person from whom government collects
money in first instance.
• While incidence of a tax is on person who finally bears burden of a
tax.
• For example: Suppose government levies a tax on electric goods in
Bangladesh. Tax will be paid to Government in first instance by
manufacturers of electric goods. Impact of tax is, therefore, on
them. If manufacturers of electric goods industries add tax to price
and succeed in selling goods at higher prices of electric goods to
consumers, burden of tax is thus shifted on to consumers.
 Distinguish between impact and incidence of taxes

1. Impact refers to the initial burden of the tax, while incidence refers
to the ultimate burden of the tax.
2. Impact is at the point of imposition, incidence occurs at the point
of settlement.
3. The impact of a tax falls upon the person from whom the tax is
collected and the incidence rests on the person who pays it
eventually
4. Impact may be shifted but incidence cannot. For, incidence is the
end of the shifting process. Sometimes, however, when no shifting
is possible, as in the case of income tax or such other direct taxes,
the impact coincides with incidence on the same person.
 Incidence and Effects
• The effect of a tax refers incidental results of the tax.  
• There are several consequences of imposition of tax, for example,
decreased demand.
• The imposition of an excise duty on sugar, we have can is shifted
ultimately to the consumer of sugar.
• The incidence is on the consumer.
• But the effects of this duty may be far-reaching.
• A heavy excise duty may cripple the industry.
• The manufacturer’s profits will be reduced.
• Wages may be reduced.
• Labour and capital may have to leave the industry.
 Forms of Escape from Taxation
 Shifting of tax: Shifting means the process of transfer, i.e., the
passing of the tax from the one who first pays it to the one who
finally bears it.
• It is through this process of shifting that the incidence of a tax
comes finally to rest somewhere.
• The process of shifting may be slow or may be only partially
effective so that the burden of a tax may not fall entirely on the
person, who is intended to bear it.
• To what extent burden of tax fall on buyer and seller depends upon
many factors:
 Nature of Tax
 Elasticity of demand
 Elasticity of supply
 Nature of market
 Cost conditions many factors
 Kinds of Shifting
 Forward shifting occurs when the burden of the tax is transferred from a factor
of the production to the factor of distribution.
 Backward shifting occurs when the burden of tax is transferred from the
consumer to the producer or manufacturer.
 Onward shifting occurs when tax is shifted to two or more times either forward
or backward.
 Theories of tax shifting:
a) Concentration theory or surplus theory: According to concentration theory,
each tax tends to concentrate on a particular class of people who happen to
enjoy surplus from the products.
b) Diversion or Diffusion theory: The diffusion theory states that the tax
eventually got diffused in the entire society. That is, the final placing of tax is
not one but multiple. The process of diffusion took place through shifting or
through process of exchange.
c) Demand and supply theory: It advocates that a tax incident can only be shifted
through sales/purchase transactions and it is possible through a revision of the
price. A price revision is possible and determined by relative values of demand
and supply elasticity. If tax can therefore be shifted only through a shift in
demand or a shift in supply curve.
 Forms of Escape from Taxation
 Capitalization: This refers to the reduction in the price of the tax
object to the capitalized value of future taxes which the purchaser
expects to be called upon to pay. Ex: A reduction made by the
seller on the price of the real estate, in anticipation of the future
tax to be shouldered by the future buyer.
 Transformation occurs when the manufacturer or producer upon
whom the tax has been imposed pays the tax and endeavor to
“recoup” ( make up for ) himself by improving his process of
production
 Tax Evasion is the practice by the taxpayer through illegal or
fraudulent means to defeat or lessen the amount for tax. This is
also know as “tax dodging.”
 Cont…
 Tax Avoidance is the exploitation by the taxpayer of legally
permissible methods in order to avoid or reduce tax liability. This
is also known as “tax minimization.”
 Tax Exemption is the grant of immunity or freedom from a
financial charge or obligation or burden to which others are
subjected.
 Grounds for tax exemption:
 Contract, wherein the government is the contracting party.
 Public policy
 Reciprocity