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Source link: http://archive.mises.org/3437/who-bears-the-burden-of-the-tax/

Who Bears the Burden of the Tax?

April 7, 2005 by

This question came into the Institute from Allen Sukholitsky, a study at Columbia:

I had a few exchanges with my professor about the producer/consumer burden of the excise tax and she gave me numbers that appeared to prove that an excise tax can be partially given to the consumer. She gave me 3 combinations of price/quantity to prove the point.

Combination A, this combination reflects normal market equilibrium without a tax: Price of a good is $10, quantity sold is 5. With no tax, the profit is 50 – 10 (for the cost of the 5th unit) = 40 minus the cost of 4 units.

Combination B, this combination represented my suggestion that a producer should/must absorb the tax entirely: Price of a good is $10, tax is $2 thus profit is 50 – 10 (cost of 5th unit) – 10 (tax on 5 units) – cost of 4 units = 30 – cost of 4 units.

Combination C, this combination represents my professors suggestion that the firm cut its production by one unit: Price of a good is $11, 4 units sold, tax is again $2 so profit is 44 – 8 (tax on 4 units) – cost of 4 units = 36 – cost of 4 units.

By increasing the price/lowering the quantity in combination C, the firm retained a higher profit than in combination B meaning that in increasing the price/lowering quantity, some of the firm’s loss was shared by the consumer.

Is this correct? Did I misunderstand what Murray Rothbard wrote when he said that an excise tax falls entirely on the producer?

My answer follows: If the tax is an excise tax imposed on a single good, say a 20 percent tax on citrus products, than firms producing fresh oranges, grapefruits, lemons and citrus juices, ice pops, fruit salads etc. would initially face higher costs of production and diminished profits.

As a result the marginal firms in the industry may suffer losses and go out of business while the more efficient firms would cut back on their outputs eventually causing the supply curves of citrus products to shift to the left along given demand curves. So the 20 percent tax itself could not simply be tacked onto the price by firms and passed on directly to consumers while they maintained their profits unchanged. It is in fact the destructive effect of the tax on firm’s profits which works its way through supply and demand that eventually causes prices to rise to consumers.

Second, becauseconsumers can and will substitute other types of fruits and juices as citrus prices rise, firms will not be able to increase prices by the full 20 percent; depending on the availability of substitutes and the elasticities of the demand curves, the percentage increase in price could be a great deal or only a little less than 20 percent. Up to this point the Austrian analysis pretty much follows the standard neoclassical analysis of an excise tax.

Ultimately, in the long run–and this is the distinctive Austrian point–the brunt of the tax will be shifted backwards to the owners of the original factors specific to citrus fruit production, in this case, citrus growers who own the orange and lemon groves whose capital values will fall greatly as a result of the fall in the demand for raw citrus produce. The workers in these areas, unless they are highly specialized in citrus fruit production, will not suffer a great loss of income because their services are nonspecific and they will be able to leave to find jobs at nearly comparable wages in other agricultural industries if the citrus growers try to lower their wages.

Consumers will suffer however to the extent that the least efficient growers stop producing and allow their land to lie fallow because they can’t even cover their wage bills. If this occurs there will be a greater scarcity of citrus products and permanently higher prices to consumers.

The higher the tax, the greater this latter effect will be. A real world illustration is what happened to the yacht industry in New Jersey in the early 1990′s when congress passed a 50 percent luxury tax on autos, airplanes and boats over $100,000. The demand for these luxury items were so elastic that yacht orders fell from around 400 the year before to 10 the year after the tax.

Almost all yacht builders closed down and many of their specialized workers had to take much lower paying jobs as crabbers, fishermen, boat guides etc. Consumers faced much higher prices for yachts even in the long run until the tax was repealed.


Tom Dougherty April 7, 2005 at 7:28 pm

The economics of an excise tax tells us that an excise tax causes the marginal cost of producing the taxed good to rise. The increased marginal cost causes marginal firms who were earning zero economic profit to leave the industry. As marginal firms become submarginal and leave the industry, the supply of the goods fall. The price of the taxed good then rises. Who pays what portion of the tax – consumer and producer – is determined by the elasticity of the supply and demand curves. The main point of this is that the cost of the tax is NOT simply shifted forward on to the consumer from the producer. The price of the good rises only when the supply of the good is reduced. I think most good economists still believe that supply and demand determine price; price is not determined by cost.

Two lessons from this are: 1) supply and demand determine the price and 2) the cost of the tax cannot be simply shifted forward on to the consumer.

A national sales tax would be a tax on all goods, not just a tax on one good like the example above. Murray N. Rothbard, in his book “Power and Market”, shows that a consumption tax will simply be a tax on income. He argued that the same principles that apply to an excise tax also apply to a national sales tax, i.e., 1) supply and demand determine price 2) the cost of the tax cannot be simply shifted forward on to the consumer. What this means is that without a reduction in supply caused by the tax prices will not rise. In the case of the excise tax, submarginal firms and resources leave the taxed industry to be employed somewhere else in the economy. However, there are no untaxed industries for firms and resources to go to with a national sales tax. Only to the extent that resources become unemployed will prices rise.

Firms then will be burdened with the entire tax. Although taxes cannot be simple shifted forward on to the consumer without a reduction in supply, taxes can be shifted backward on to the factors of production. The reduction in net income to firms will be imputed back on to the factors of production. The reduction in net income will mean less interest earn by capital, less rent earned by land, and less wages earned by labor. What Rothbard has shown is that a general sales tax is not a tax on consumption, but actually a tax on income.

I have tried to present his argument as briefly as possible, but as a result, I have done some injustice to his argument. His chapter on taxation in “Power and Market” should be consulted for the entire argument.

Tom Dougherty April 7, 2005 at 7:32 pm

Oops. I didn’t see that there was an answer already provided.

billwald April 8, 2005 at 8:23 pm

The traditional arguments were devised back when half the people lived in poverty and spent half their life energy getting enough food to stay alive. Now days less than 5% of personal income goes for food and most of our money is spent on non necessities. No one needs a new car or 3,000 square feet for 4 people to live in. Does the change from a poverty calculus to a luxury calculus change the concept of supply and demand?

Tom Dougherty April 9, 2005 at 8:01 pm

Over at LRC.com Thomas Woods writes the following:

Murray Rothbard’s book For a New Liberty made me think about the world differently.

Murray Rothbard’s book, For a New Liberty, made me think about the world differently.

Those commas would belong there only if For a New Liberty had been Rothbard’s only book.”

Above, I wrote, “Murray N. Rothbard, in his book “Power and Market”, shows that a consumption tax will simply be a tax on income.” Is this incorrect? Perhaps I should have wrote, “Murray N. Rothbard in his book “Power and Market” shows that a consumption tax will simply be a tax on income.”

Curt Howland April 9, 2005 at 9:27 pm

Bill Wald, you are more than welcome to donate every penny you make more than what you consider “needed” to survive, to whomever you feel is most worthy.

I, however, am very glad to live better than the kings of those times when most people lived in what would be considered now abject poverty. I’m even more glad to know that I can actually have property to give to my children so that they have a “stake” in life instead of having to repeat every step I’ve taken just to stay alive.

Human beings unique niche is that we change the environment to fit our needs rather than always adapting to the environment. We have adapted our environment to the point where we produce enough food for everyone, everywhere, to live. We produce enough material goods for everyone, everywhere, to live well. And it is only getting better.

The fact is someone can produce value for others such that they can afford a new car, whether you agree with them on their choice or not. By being good to their fellow people, they have earned that choice.

Have you?

Brent Nelson April 10, 2005 at 1:15 pm

Before you get into a debate over where a tax burden falls, you’d better
decide what a tax burden is first.

As an aside, the example from Mr. Sukholitsky’s teacher is in error, only 4
goods would be sold for combination A.

Combination A states that consumers will buy 5 goods at a price of $10, with
the cost of producing the fifth unit being $10. Combination C states that
consumers will buy 4 goods at a price of $11. But the producer will maximize
profit, not number of goods. For combination A, they would sell 4 goods at
$11 instead:

  • A – Selling 5: $50 – (cost of 5th=10) – (cost of 4) = $40 – (cost of 4)
  • A – Selling 4: $44 – (cost of 4)

So the profit maximizing price is not $10 in combination A. It may not be $11
either, but we only have sufficient information to know it isn’t $10.

Alternately, to reconcile combination A with combination C, the cost of producing
the 5th good cannot be more than $6. At $5, profit from selling 5 would be higher
than selling only 4:

  • A’ – Selling 5: $50 – (cost of 5th=5) – (cost of 4) = $45 – (cost of 4)
  • A’ – Selling 4: $44 – (cost of 4)
  • B’ – Selling 5: $50 – (cost of 5th=5) – (tax=10) – (cost of 4) = $35 – (cost of 4)
  • C’ – Selling 4: $44 – (tax=8) – (cost of 4) = $36 – (cost of 4)

So at last we have a case that should make the teacher happy: Without the tax, 5
goods would be sold at $10 for a profit of $45-(cost of 4). With the tax, 4 goods
would be sold at $11 for a profit of $36-(cost of 4).

The effect was that four people, all of whom were willing to pay $11 or more for a
good, paid $11 instead of $10 for it. One person, who was willing to pay only $10
for a good, used his money for something else. The producer made $9 less in profits.
They are all burdened by the tax. Someone in the government gets to spend $8,
he benefits from the tax.

Some people will insist that the tax burden on people is equal to the tax income for
the government. And that each dollar of tax burden be assigned to one individual.
In that case, shouldn’t the numbers add up?

If you say that the four consumers that actually bought a good were each burdened
with $1 of taxes because they paid $11 for a good they would have only had to pay
$10 otherwise, then where does the other $4 in taxes come from? The producer by
default? Rather arbitrary, and that leaves a circular definition when trying to
reconcile tax income with tax burden.

  • Tax Income = Tax Burden
  • Tax Burden = Consumer Burden + Producer Burden
  • Consumer Burden = Price change x # of consumers
  • Producer Burden = Tax Income – Consumer Burden

You could just as easily say that the producer, having lost $9 in profits, paid the
full $8 tax burden plus more.

  • Tax Income = Tax Burden
  • Tax Burden = Producer Burden + Consumer Burden
  • Producer Burden = Profit change
  • Consumer Burden = Tax Income – Producer Burden

You could allow that the tax burden is not equal to the tax income, so the tax
burden is the $9 lost profits by the producer plus the $4 extra paid by the consumers
for a total “burden” of $13 to reappear as $8 in tax income. That still leaves
out the man who was willing to pay $10 for a good. And it leaves the tax burden an even more useless calculation.

I have no doubt that people will come up with ever more complicated schemes for
measuring the impact of taxes. But all these schemes rely on knowing the
unknowable — what producers and consumers might have done were the situation

As for Rothbard on taxes: The demand curve for the goods does not change; Only the supply curve is shifted, just as if the cost of producing the good
was increased. So it seems fair to say that it is the producer that is

Brent Nelson April 11, 2005 at 4:03 pm

A thorough Heritage Foundation article on the subject of tax burden.

workforall October 5, 2005 at 11:39 am

THE IRISH FAIR TAX MODEL. How to boost the economy to 5% growth.

Irish wealth grew with over 167% between 1984 and 2002. Average European wealth grew at less than a quarter of that pace. Irish industrial jobs increased with 35% in this period, while in the rest of Europe industrial employment caved in. While the rest of the world was booming, the European economy gradually slided into stagnation or even recession.

Why is Ireland so different? Why could Ireland devellop into the second most prosperous country of Europe in barely a half generation of time? The Irish socio-economic model is a perfect synthesis of the social welfare state and Anglosaxisch liberalism. Its model differs from the rest of Europe by its “fair tax system”: an optimal combination of MODERATE AND EFFICIENT GOVERNMENT SPENDING (35% of GDP) and A BALANCED REPARTITION of the TAX BURDEN between direct and consumption taxes.

The irish model provides the incentives for productive contribution, for dynamic entrepreneurship and a high participation rate. The Irish model is successful. Today Ireland meets the challenges of globalisation and the demographic time bomb. Ever more European countries adopt Irish policies, particularly in the East.

Also in England, France, Belgium, Holland and Germany could boost growth, job creation, and wealth by implementing the strategy of decreasing their demotivating taxation, and shifting the tax burden from income to consumption. Ireland showed that it can be done and that the strategy works. Where does one wait for?

More over the Irish success story, how and why can be found at following adresses:
(Dutch and Frensh versions now available at the same web site)


Earle Attianese March 6, 2010 at 6:03 pm

Which is a great piece, usually nice to learn a lot more about aviation.

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