Tax shifting describes the phenomenon whereby the tax burden of a government-imposed tax is not borne solely by the taxpayer, but is shifted between consumers and producers based on market supply and demand. Tax shifting determines who ultimately bears the burden of a tax, and it has major implications for equitable taxation principles and policy design.
Governments levy taxes to raise revenue for their fiscal operations, but the question of who to tax and how much is very important because one of the principles of tax policy is equitable taxation, or the fair distribution of the tax burden. Tax policy should be fair because taxes are not just a way for governments to raise revenue; they have a real impact on people. How taxes are levied and how the burden is distributed can have a significant impact on social justice and economic efficiency.
Once a government determines who pays a particular tax, it enforces the obligation to pay through tax laws, but in practice, it is common for the tax burden to be shifted from one taxpayer to another, a phenomenon known as tax shifting. Tax shifting is the transfer of a tax burden in the course of an economic transaction to an economic entity other than the original intended taxpayer. This is complicated by the elasticity of demand and supply in the market, or sensitivity to price changes.
For example, suppose a government imposes a goods tax on ballpoint pens of 100 won per stack on the producer. If 1 million sticks were trading at 1,500 won per stack before the tax was imposed, the producer would have to pay a total of 100 million won in taxes. The producer, who will lose money because of this, will be unhappy with the price of 1,500 won and will try to increase the price by 100 won. Once the producer is dissatisfied, the price starts to rise, but not indefinitely. The producer’s dissatisfaction is alleviated by the increase in price, but the consumer’s dissatisfaction increases. Eventually, the market’s price adjustment process reaches a point where the opposing forces are balanced, and a new price is formed between 1,500 and 1,600 won. This means that the producer, as a legal payer, will pay all the taxes, but because the price is higher, he will actually pay less tax per sack. Consumers, on the other hand, will pay a higher price, so they will pay the taxes on the increased price.
On the other hand, tax shifting doesn’t only happen in one direction. Let’s say you charge the same tax to the consumer. The consumer has to pay 1,500 won per sack to the producer, so they actually have to spend 1,600 won. Consumers are bound to be unhappy about this. When the consumer’s dissatisfaction is reflected in the market, the market’s price adjustment function is triggered, causing the price to decrease, and the consumer is ultimately relieved of the tax burden by the amount of the price decrease. In other words, even if the government imposes a tax on the consumer, the tax is passed on to the producer.
But how does the actual burden on each side get determined? It depends on how consumers or producers react to changes in product prices. For example, if consumers don’t change their purchases significantly in response to a price change, then consumers will pay more of the tax no matter which side you tax. When taxing producers, the demand for higher prices is more strongly reflected, and the new price will be set at a much higher level than it would have been otherwise. In other words, the tax on producers is heavily passed on to consumers. However, when taxing consumers, the demand for lower prices is less strongly reflected, so prices don’t fall as much. As a result, consumers bear most of the tax.
In addition, when producers try to shift the tax burden to consumers, the degree to which consumers accept it is also an important factor. For example, for products like necessities, producers can easily pass on the tax burden to consumers because consumers are less sensitive to price increases. On the other hand, for luxury goods or products with many substitutes, consumers are more likely to react sensitively to price increases, reducing demand or substituting other goods. In this situation, the producer bears a significant portion of the tax.
This phenomenon of tax shifting makes it difficult for governments to determine who is the true tax payer. If this phenomenon is not fully accounted for when designing tax policies, it can lead to unintended consequences, such as disproportionate tax burdens on certain groups of people or increased economic imbalances. This has the potential to undermine the equity and efficiency of taxation, making it critical for policymakers to understand and account for the mechanisms of tax shifting.
