What is the Effective Incidence of Tax?

By BYJU'S Exam Prep

Updated on: November 9th, 2023

The Effective Incidence of Tax refers to the situation in which the original bearer of a tax passes it on to a second person, who then bears the burden and pays the tax. As a result, the individual who bears the tax burden is known as the tax incidence. On the other hand, the term ‘formal incidence of tax’ refers to the entity or person who is required to pay the tax but passes it on to another person/entity.

Effective Incidence of Tax

Effective incidence of tax refers to a circumstance where the person who ultimately pays a tax may not be the actual bearer of the tax burden. The process of determining who bears the burden is referred to as the incidence of taxation.

‘Formal incidence of tax’ refers to the person who is legally responsible for the tax burden but fails to do so and passes the burden onto another. The formal incidence of a tax will more often be different from the effective incidence of tax owing to several factors and price mechanisms.

Tax incidence is a commonly used term in the world of economics. Tax burden basically describes a case where the buyers and sellers split the tax burden. Hence, it depicts the distribution of the tax obligation that must be covered by the seller and buyer. Lastly, the traditional concept of incidence of tax has been criticized in modern economic literature in the past few years.

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