Answer to Question #216515 in Microeconomics for Y. McGee

Question

·         (1) Explain the difference between tax impact and tax incidence.

·         (2) Identify and explain the three forms of shifting that can occur with tax incidence.

Answer 1

Question 1

Tax impact relates to the initial burden of the tax, while tax incidence relates to the ultimate burden of the tax. The impact of a tax descends upon the individual from whom the tax is obtained, and the incidence resides on the individual who pays it ultimately. Tax impact arises when taxes are imposed, whereas tax incidence occurs when taxes are paid. The tax impact can be shifted, but not the tax incidence.

Question 2

The three forms of shifting that can take place with tax incidence include forward shifting, backward shifting, and neutral shifting. Forward shifting happens when businesses pay taxes, but the majority of the tax expense is transferred to individuals who purchase the taxed items. Backward shifting occurs when the product's price is taxed the same, but the tax pricing is meted by those involved in manufacturing it. Neutral shifting occurs when the tax on luxury items inflates their price to the buyer.