Legal vs. Economic Incidence: The legal incidence of a tax (who is legally obliged to pay it) does not determine who economically bears the burden of the tax.
Economic Incidence Rule:
The more elastic side of the market will bear a smaller share of the tax burden.
The less elastic (more inelastic) side of the market will bear a greater share of the tax burden.
Elasticity and Tax Burden
Elastic Demand vs. Inelastic Supply:
When demand is more elastic than supply, demanders pay a smaller share of the tax.
Suppliers pay a larger share since they cannot easily escape the tax.
Inelastic Demand vs. Elastic Supply:
When supply is more elastic than demand, suppliers can escape the tax more easily.
Buyers then bear a larger share of the tax burden.
Diagram Analysis
Using Diagrams to Determine Tax Incidence:
Draw the demand and supply curves.
Insert the tax wedge into the diagram.
Read off the price changes for buyers (Point B) and sellers (Point D).
Intuition Behind Elasticity and Tax Incidence
Elastic Demand:
Demanders have good substitutes for the taxed good and can escape the tax.
Inelastic Demand:
Few substitutes are available, making it hard to escape the tax.
Elastic Supply:
Resources can easily move to other industries, allowing suppliers to escape the tax.
Inelastic Supply:
Resources are fixed and not easily repurposed, making it difficult for suppliers to escape the tax.
Applications
Social Security Taxes
Incidence on Workers vs. Employers:
The demand for labor is more elastic than the supply.
Workers bear most of the tax burden due to the inelastic supply of labor.
Effect on Wages:
Workers' wages tend to decrease as they bear more of the tax burden.
Without the tax, wages would be higher.
Health Insurance Mandates
Comparison to Taxes:
A health insurance mandate is similar to a tax since it increases employer costs.
Economic Incidence:
Primarily borne by workers if the supply of labor is less elastic than the demand.
Real wages may fall due to the mandate.
Conclusion & Next Steps
Upcoming Topics:
The next lecture will address the revenue effects of taxes and their potential to create deadweight loss.
Practice & Further Learning:
Engage with practice questions to test understanding.
Continue to the next video for more on tax effects.