What are the Different Theories of Tax Shifting Incidence?

By Ritesh|Updated : January 2nd, 2023

The different theories of tax shifting incidence are the Musgrave method, the diffusion theory, the concentration theory, and the demand and supply theory of incidence. Canard and Mansfield developed the diffusion theory. By raising the sales price or lowering the purchase price during the exchange of commodities, the taxpayer shifts the tax burden to the buyer or supplier. This is referred to as a tax shifting in economics.

Different Theories of Tax Shifting Incidence

According to tax incidence theory, lump-sum tax payments are an appropriate way to measure individual welfare losses or burdens in a first-best policy environment when using common willingness-to-pay metrics like Hicks' Compensating or Equivalent Variations.

Factors Affecting the Tax Shifting Incidence

Elasticity:

  • When calculating incidence, we take into account both supply and demand elasticity.
  • If the demand for taxable goods is elastic, the tax will often be passed along to the producer, but if the demand is inelastic, the tax will mostly be absorbed by the consumer.
  • The burden will typically fall on the buyer in elastic supply scenarios and the producer in inelastic supply scenarios.

Price:

  • Price is crucial because it is the only way to shift the tax burden.
  • The tax does not change if the price remains the same.

Time:

  • The producer is unable to make immediate changes to the machinery or plant.
  • Therefore, if demand declines due to price increases brought on by the tax, he might be unable to limit production and pay some of the tax.
  • Eventually, a change could be made, and the tax could be charged to the customer.

Cost:

  • Taxes increase the price, which in turn decreases demand, which in turn lowers output.
  • Expenses are impacted by production scale changes, which vary depending on whether the industry has decreasing, increasing, or ongoing costs.

Summary:

What are the different theories of tax shifting incidence?

Canard and Mansfield developed the diffusion theory. Four different theories demonstrate the impact of tax shifting. Diffusion theory, concentration theory, demand and supply theory of incidence, and the Musgrave method are a few of the theories.

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