Impact, Incidence and Tax Shifting

Tax Impact
This is the first point of contact of tax on the taxpayers. It’s upon those persons who bear the first responsibility of paying it to the government.

Tax Incidence
This is the final resting place of tax. It’s upon those economic units which finally bear the money burden of it and which the tax money comes from. It involves the transfer from one person on whom the tax is imposed initially to the ultimate taxpayer who bears the ultimate money burden of the tax. The tax transfer process is known as the tax shifting while the settlement of the burden on the ultimate taxpayer is known as tax incidence.

Tax shifting
It is the process of transferring the tax liability to other people through transactions. Tax shifting can be backward or forward.

Forward Shifting
It occurs when an initial taxpayer passes the tax in part or as a whole to the buyer of his product which was taxable. This occurs by the inclusion of the tax element in the product’s price e.g. sales tax, VAT, customs and excise duty etc.

Backward Shifting
It occurs when the producer shifts the money burden of the tax onto the suppliers of the factors of production by urging them to accept lower wages or prices for their services.
Taxes may be shifted depending on the extent of the rise in the price of the commodity. If the price of the commodity rises in equal to the amount of the tax, the entire money burden of the tax is shifted from the producer to the consumer. If the price of the commodity does not rise with the entire money burden of the tax, the consumer will only pay part of the tax (partial shifting) which is equal to the difference between the new price and the price before tax price of the commodity. If the price doesn’t rise even after the tax levy, the tax incidence will remain with the producer or there will have been a backward shifting. It’s very uncommon that backward shifting will occur.

Factors Influencing Tax Shifting

a) Elasticity of Demand and Supply
The more elastic the demand, the lower the incidence on the sales. The higher the elasticity of supply, the higher the incidence on supply.

b) Nature of Markets
In an oligopolistic market, tax shifting to buyers is higher since few sellers can team up to determine the market price. For a monopoly, the entire tax burden is borne by the buyer.

c) Time Available for Adjustment
The person (buyer or seller) who can adjust will be able to shift tax e.g. if the buyer can shift to substitutes products, then the seller will bear the tax burden.

d) Geographical Location
If taxes are imposed in certain regions, it’s hard to shift to consumers since they will move to regions of low tax.

e) Government Policy on Pricing
In case of government price control, it will be impossible for the suppliers to increase prices hence impossible to shift the tax burden to the buyers.

f) Nature of Tax
Whether direct or indirect tax? Direct taxes such as PAYE and corporation tax cannot be shifted whatsoever. For indirect taxes, these can be shifted through price increases.

g) Rate of Tax
If too low, the producer may absorb it and retain his customers. If too high, it can be partially or fully shifted to consumers

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