Elasticity and Tax Burden

Tax Burdens are Generally Shared by Consumers and Producers

The burden of a tax is generally shared by the producers and consumers in a market.  In other words, the price that the consumer pays as a result of the tax (inclusive of the tax) is higher than what would exist in the market without the tax, but not by the entire amount of the tax.  In addition, the price that the producer receives as a result of the tax (net of the tax) is lower than what would exist in the market without the tax, but not by the entire amount of the tax.  (Exceptions to this occur when either supply or demand is perfectly elastic or perfectly inelastic.)

Tax Burdens and Elasticity

This observation leads naturally to the question of what determines how the burden of a tax is shared between consumers and producers.  The answer is that the relative burden of a tax on consumers versus producers corresponds to the relative price elasticity of demand versus price elasticity of supply.

Economists sometimes refer to this as the "whoever can run from a tax will" principle.

More Elastic Supply and Less Elastic Demand

When supply is more elastic than demand, consumers will bear more of the burden of a tax than producers will.  For example, if supply is twice as elastic as demand, producers will bear one-third of the tax burden and consumers will bear two-thirds of the tax burden.

More Elastic Demand and Less Elastic Supply

When demand is more elastic than supply, producers will bear more of the burden of a tax than consumers will. For example, if demand is twice as elastic as supply, consumers will bear one-third of the tax burden and producers will bear two-thirds of the tax burden.

An Equally-Shared Tax Burden

It's a common mistake to assume that consumers and producers share the burden of a tax equally, but this is not necessarily the case. In fact, this only occurs when the price elasticity of demand is the same as the price elasticity of supply.

That said, it often looks like the tax burden is shared equally because supply and demand curves are so often drawn with equal elasticities!

When One Party Bears the Tax Burden

Though not typical, it is possible for either consumers or producers to bear the entire burden of a tax. If supply is perfectly elastic or demand is perfectly inelastic, consumers will bear the entire burden of a tax. Conversely, if demand is perfectly elastic or supply is perfectly inelastic, producers will bear the entire burden of a tax.