Why statutory incidence matters.

Author:Lawson, Robert A.
  1. Introduction

    Economists frequently claim that the economic incidence of a tax is invariant to its statutory or legal incidence (Rosen and Gayer 2014, p. 303). That is, whether the tax authorities physically collect a tax from the buyer or the seller, the ultimate impact of the tax on prices, quantities, and the distributions of the gains from trade will be identical. The reason for this is that the party bearing the legal incidence of a tax may change his or her behavior in ways that cause some, or even all, of the tax burden to shift to other parties. For example, taxing the seller of an item may cause the seller to raise prices, thereby shifting part or all of the tax to buyers. The widely understood price-increasing consequences of cigarette taxes levied on tobacco firms or alcohol taxes levied on beer and spirits producers are examples of this phenomenon.

    Suppose the state levied a 5 percent tax on a product or group of products and required the seller to remit the tax. Alternatively, suppose that the state levied a 5 percent tax on a product or group of products but required the buyer to remit the tax. Economics teaches that the true tax burden would be same in both cases. When the tax is levied on sellers, they pass some of the tax along to buyers in the form of higher prices When the tax is levied on buyers, the amount they are willing to pay decreases to offset some or all of the tax. In both cases, the result is the same: the ultimate sharing of the burden among these stakeholders depends on the relative elasticities of supply and demand in the market. Hence, for the purposes of economic incidence, the standard conclusion is that legal incidence does not matter. (1)

    Economists' exposition of tax incidence is fine as far as it goes, and understanding that true tax incidence is independent of the tax's statutory imposition is an important concept. However, this standard treatment ignores the fact that tax policy is made by politicians and interpreted by courts. Consequently, what are mere words to economists--the party bearing the statutory burden of a tax even though the economic burden is invariant--do sometimes turn out to matter. In this paper, we illustrate this point with two examples.

  2. Example 1: Ohio's Commercial Activity Tax

    Most states choose not to tax groceries purchased for home consumption. At least one state, Ohio, has enshrined this policy choice in its state constitution. However, Ohio's constitutional prohibition on taxing groceries has been eroded by a court's reliance on statutory incidence rather than economic incidence.

    On July 1, 2005, Ohio implemented a new tax of 0.26 percent (after ramping up over a phase-in period) on Ohio businesses. The new tax, called the Commercial Activities Tax (CAT), was levied on "gross receipts, which is defined as the total amount realized, without deduction for the cost of goods sold or other expenses incurred, from activities that contribute to the production of gross income" (Ohio Department of Taxation 2008, p. 19). Businesses with annual gross receipts of $150,000 or less were not subject to the CAT.

    Gross receipts taxes are not new; Adam Smith ([1776] 1994) wrote of a version known as the alcavala, which operated from the fourteenth through the eighteenth centuries in Spain. In the first half of the twentieth century, many European countries relied on gross receipts or "turnover" taxes until later replacing them with value added taxes. In modern times, Ohio is not alone in levying a gross receipts tax. Malm (2014) reports...

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