Meaning and Importance of Incidence of a Tax

Meaning of Incidence of a Tax:

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.

Importance of Incidence of a Tax:

To distribute the burden of taxation in an equitable manner, it is necessary to impose taxes in accordance with the ability to pay the taxpayers. This can only be done when the taxing authority is able to locate the ultimate money burden, i.e., the incidence of taxation. Hence, for the just distribution of the burden of taxation, it is essential to know on whom the incidence of various taxes actually falls. For instance, the government may impose an excise duty on the manufacturer of shoes with the impression that the manufacturer of shoes may not be able to raise the price of shoes. This may be, because the government may think that the shoe manufacturers are earning huge profits and they have the ability to bear the burden of excise duty themselves. The government is correct in its estimate if the prices of shoes do not rise, i.e., if the burden of excise duty is not shifted to the consumers. But if they do not rise, the burden of excise duty is shifted partially or wholly to the consumers, and hence, the government efforts to tax the manufacturers may be nullified by the process of shifting. Therefore, to know in what circumstances, and to what extent the incidence of tax may be shifted, the study of shifting and incidence is important.

However, the incidence of taxation does not alone guide the fair distribution of taxes, as it is very difficult to trace the real incidence of a tax. Prof. Cannon has also pointed out that “the mere fact that the incidence of tax is on a particular individual or class does not necessarily imply that he or that particular class is bearing a heavier burden (in the real sense) than others. In fact, the burden of a tax may be felt by those who do not pay, as well as by those who do. Hence, the persons, who pay a tax, are often less injured by its imposition than those who pay no portion of it. The man, who goes two miles out of his way daily to avoid a bridge toll, would be more benefitted by the freeing of the bridge than many of those who pay the toll.”

The discussion of incidence, thus, depends largely on the investigation of shifting of taxation. The real problem before us is to ascertain the conditions according to which a tax is shifted forward, backward, or not at all, only when we understand whether, why, and how a tax is shifted, then we can discover its actual incidence. And when we are able to ascertain the incidence of a tax, then we can proceed to discuss the wider effects of a tax. Hence, the analysis of the incidence of a tax is important. However, the difficulties in the analysis of tax shifting are so great that some writers profess to see little significance in the efforts to analyze such complicated phenomena. It is often impracticable, if not impossible to verify the theoretical reasoning of economists concerning the shifting and incidence of taxes by statistical investigations, but a number of such investigations have strengthened the view that it is an abstract analysis by finding evidence in support of this conclusion.

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