Sunday, September 7, 2008

Can Governments Choose Who Pays Taxes?

With the Presidential election campaign heating up in the US, the candidates often trade philosophical barbs regarding who should be taxed less/more and by how much. For example, Barrack Obama has repeatedly stated that he will lower taxes for 95% of American families. While politicians can use tax policies to increase or decrease activity for various sectors, they actually have a lot less control over who gains/loses from tax changes than people believe.

To illustrate, Wikipedia demonstrates a simple example where a government imposes a tax of $1 on every barrel of apples. They can either tax the buyer at the source (a sales tax of $1) or they can tax the supplier (an income tax of $1 per barrel sold). However, as the example illustrates, it doesn't matter who technically pays the tax, as supply and demand elasticities will determine who actually shoulders the burden of the tax.

Extrapolating this phenomenon to the supply and demand of labour suggests that whether politicians slap a tax on businesses or on workers, the effect will be determined by the market (based on the elasticities of supply and demand for labour). If businesses aren't expanding and have elastic demand for labour, workers will shoulder the burden of these taxes even if they are technically imposed on businesses.

Based on this conclusion, politicians are spending a lot of time and effort arguing over measures over which they have no control!

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