Glossary – Tax Incidence

The effect a tax has on the distribution of economic welfare. Tax Incidence describes how the burden of a tax is shared among producers and consumers in a market.

Assume a new per unit tax of 1$ is imposed on ice cream. As a result, producers increase the price of ice cream from 2$ to 3$. At first view, it may seem as if consumers have to bear the entire burden of the tax. However, some buyers may decide not to buy ice cream for 3$, because that is too expensive for them. As a result, total revenue received by the producers will fall (since they do not receive the additional tax revenue). In other words, unless demand is perfectly unelastic, consumers and producers will usually share the burden of a tax, at least to a certain degree. To see how to calculate tax incidence, check out this article.