Distinction Between Incidence and Effect of Taxation

Distinction Between Incidence and Effect of Taxation:

Meaning of Incidence- The incidence of a tax refers to the money burden of a tax on the person who ultimately bears it. In other words, when the money burden of a tax finally settles or comes to rest on the ultimate tax-payer, is called the incidence of a tax. The incidence of tax remains upon that person who cannot shift its burden to any other person, i.e., who ultimately bears it. Thus, there are three distinct conceptions- the impact, the shifting, and the incidence of a tax, which correspond respectively to the imposition, the transfer, and the settling or coming to rest of the tax. The impact is the initial phenomena, the shifting is the intermediate process, and the incidence is the result.

Mrs. Ursula Hicks, however, classified the incidence of taxation into two categories: formal incidence and effective incidence of taxation. The Taxation Enquiry Commission adopted the definition as given by Mrs. Hicks while studying the problem of the incidence of taxation in India. The Commission defined the formal and effective incidence of taxation as “Formal incidence is the money burden of taxes resting with the subject on whom the burden is intended by the taxing authority to fall, and the effective incidence is the real or final distribution of tax burden after its shifting in consequences of changing demand and supply condition of taxed commodity or services. In this sense, the formal incidence is what Dalton calls the direct money burden of tax and the effective incidence is the indirect money burden of a tax. Thus, the formal incidence is a part and parcel of the theory of incidence of taxation while effective incidence is a part of the study of the general effects of taxation. To be more clear, formal incidence refers to the concept of incidence of taxation and effective incidence to the effects of taxation.

Distinction Between Incidence and Effect of Taxation- Though, it is not easy to distinguish between the incidence and effect of a tax, however, an attempt had been made here. A tax reduces the income of the person on whom the incidence rests, and therefore he may be forced to reduce his consumption or investment. Obviously, consumption and investment may be influenced by taxation. It is called the effect of taxation or the pressure of incidence, but not the incidence of taxation. The incidence of a tax and the effects of a tax can also be distinguished with the help of a specific case. Suppose a producer, as the consequence of a tax, but something more than this amount, in such case, not only is the incidence of the tax upon the consumer, but the resulting burden on the consumer is greater than the amount of the tax. The loss to the tax bearer is greater than the gain to the treasury. This may be called the pressure of incidence or the effect of taxation. Hence, the pressure of incidence or the effect of taxation includes this extra loss to the taxpayer. Moreover, this pressure or effect may be felt not only by those who pay but by those also who do not pay the tax.

For instance, a tax may affect the market demand and production, it may result in loss of incentive, motivation, and efficiency, it may cause shifting of capital, it may result in social and political unrest and so. These are termed as effects of taxation and not incidence of taxation. Hence, the difference between the incidence and effect of taxation is obvious.

This incidence of a tax is called by Dalton as the direct money burden, and the effect of a tax is called by him as the indirect money burden of a tax. He also made a distinction between the direct money burden and the indirect burden of a tax. The burden of the sacrifice of economic welfare, imposed on a person because of the payment of a tax, is called by Dalton as the direct real burden of the tax. The reduction in the consumption of a commodity as a result of a tax is called by Dalton as the indirect real burden of the tax. The former is known as the incidence of the tax and the latter as the effect of taxation.

However, Prof. Findlay Shirras did not make any distinction between the incidence and effect of a tax. Thus, he said that “every tax, no matter who pays, has its impact, beyond the direct money burden on individuals in particular and society in general, and it is unnatural to talk about incidence and effects on taxation differently.” It means the incidence and effect of tax are interlinked. But, there is general agreement among economists that the problem of the incidence of tax is to locate the person or persons who ultimately pays the tax and the social and economic effects of taxation are entirely different from it.