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 C greatness
magnitude of tax incidence
Tax Incidence
The economic effects, and therefore
the equity, of many taxes cannot be fully understood because of the difficulty
in determining where their burdens really fall. Even the individual income
tax, which is presumed to fall entirely on the legal taxpayer, has indirect
consequences in the economy; it influences decisions to work, save, and
invest, and these decisions affect other people. Perhaps the most difficult
tax burdens to pin down are those of the corporate-profits tax. Depending
on the structure and flexibility of the market within which a corporation
competes, the tax may in some cases simply lower corporate profits and
dividends; in other cases, it may broadly reduce the incomes of all owners
of property and businesses. To the extent that corporations compensate
for the tax by raising the prices of their products, the incidence of the
tax may be said to be shifted forward to consumers. To the extent that
tax-reduced corporate profit margins hold down wages, the incidence of
the tax is shifted backward to workers.
Similar disagreements arise over the
incidence of local property taxes and over the employers' share of social
security payroll taxes. Even the long-established view that retail sales
taxes are shifted forward from retailers to consumers is challenged in
a world in which wages and government transfers (that is, income payments
such as social security) are indexed, or automatically adjusted upward,
for inflation. Inclusion of the sales tax in the Consumer Price Index insulates
recipients of indexed incomes against inflation-induced tax increases and
therefore puts the burden of those increases on the recipients of nonindexed
incomes. As awareness grows of the difficulties in pinning down the burden
patterns of various taxes, the old distinction between direct (unshiftable)
and indirect (shiftable) taxes becomes relatively meaningless.
Other Effects of Taxation.
Despite the difficulties of precise
measurement, governments are appropriately concerned with the vertical
pattern of the tax burden: Does it fall proportionately more heavily on
the rich than on the poor (progressive taxation)? Does it burden everyone
to the same degree in relation to taxpaying ability (proportional taxation)?
Or does it place a relatively heavier burden on the poor (regressive taxation)?
In most modern nations, a generally progressive tax structure is considered
desirable for two reasons. First, a progressive tax is considered more
equitable (because the wealthy have more ability to pay). Second, extremes
of wealth and poverty are considered injurious to the economic and social
well-being of a society, and a progressive tax structure tends to moderate
such extremes.
On the other hand, tax rates that are
too progressive-that rise too steeply-may discourage both work and investment
by removing much of the reward. In the early 1980s concern about this problem
in the U.S. and elsewhere attracted the attention of policymakers to so-called
supply-side economics-to economic theories emphasizing the importance of
ensuring that taxes do not drain away incentives to invest, either from
individuals or from businesses. In 1986 the U.S. Congress instituted a
major overhaul of the income tax system. G.F.B. |