Arnold Kling

Who Bears the Tax Burden?

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The 2004 Economic Report of the President contains a chapter on tax incidence.


the person who is legally responsible for paying the tax may not be the one who actually bears the burden of the tax...the incidence of a tax depends upon the law of supply and demand, not the laws of Congress.

...Many observers view capital income taxes as highly progressive...However, economic analysis suggests that capital income taxes are particularly likely to be shifted, especially in the long run...capital income taxes may be partly shifted to workers through a reduction in wages.

...Because the estate and gift taxes are taxes on capital, part of their long-run burden is likely to be shifted to workers through a reduction in wage rates [This part] is therefore likely borne by ordinary workers who never receive a bequest or taxable gift.


For Discussion. How does the issue of economic incidence of taxes affect calculations of the progressivity of the tax system?


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CATEGORIES: Fiscal Policy



COMMENTS (41 to date)
Eric Krieg writes:

Who is making the calculation? Paul Krugman? I would be surprised if liberals like Krugman gave more than a parting thought to economic incidence.

It seems to me that all liberals look at is tax rates, and the more progressive those rates are, the better they like them.

Bernard Yomtov writes:

Eric,

Your comment is idiotic. The notion of the difference between economic and legal incidence of taxes is discussed in introductory economics classes, often right after the basic notions of supply and demand. It is not a political issue at all.

I know you enjoy issuing random baseless slams against Krugman and aother liberals, but this one is even stupider than most.

You have no idea what you are talking about.

Eric Krieg writes:

Yeah, you're right. I must have missed the Krugman column where he explained the true incidence of the estate tax.

Of course tax incidence is political. If it weren't we wouldn't have capital gains and estate taxes. What is stupid is to say that tax incidence isn't political.

And who advocates the estate tax? Who got it repealed?

The problem is that Krugman uses his emminence in the profession of economics as cover for his politics.

There are a lot of things in introductory economics textbooks that are political. Just because it is settled economics doesn't mean that it isn't political. Did you skip the debate here about comparative advantage?

I'd watch how you throw around the word stupid. It might boomerang back to hit you square in the head.

Tom Dougherty writes:

Tax incidence:

Taxes are political, but who actually bears the burden of the tax is an economic question. For example, the politicians wanted to stick it to the rich. So, they imposed a 10% tax on a luxury item that the rich buy. You may have heard about the luxury tax Congress imposed on the yacht industry in the early 90s. What happened was that the tax caused the luxury yacht industry to go under. The rich decided to spend their money elsewhere. Workers' wages were cut and they were laid off. The luxury tax instead of sticking it to the rich ended up sticking it to the workingman.

Politics said stick it to the rich. Economics said you’ll miss the rich and hit the workingman.

Bernard Yomtov writes:

Eric,

The fact that the legal incidence and the economic incidence are not the same is not political. Once again, it is simple economics.

Yeah, you're right. I must have missed the Krugman column where he explained the true incidence of the estate tax.

Do you really believe that just because Krugman never wrote a column about something, he doesn't understand it? Even being careful, I think that can fairly be described as a stupid thing to say.

Tom Dougherty writes:

“How does the issue of economic incidence of taxes affect calculations of the progressivity of the tax system?”

Calculation by whom, the politicians or the public? Neither is very much aware about who actually bears the burden of a tax. Most think that a tax on a good is simply passed on to the consumer. The amount of a tax passed on to the consumer is determined by the elasticity of the supply and demand schedules.

Also, how many people talk about the deadweight loss associated with a tax. “Gee, Mildred, the deadweight loss to society associated with that excise tax would be substantial.”

The point about how a tax on capital will cause a reduction in the amount of capital per capita and will lower the marginal productivity of labor (real wages) is not something the public or politicians seem to understand or be concerned about.

Dave Sheridan writes:

How does incidence affect the progressivity of the tax system?

A leading question -- but one of the right ones to ask. Proper analysis would combine the incidence both of tax rates and tax exemptions and deductions. I also favor the idea of explicitly recognizing (as Tom Dogherty does) the deadweight loss a tax causes. Incidence after all, is the measure of who actually bears the burden of a tax. Politicians mislead when they equate who bears the burden with who writes the check.

There is clearly no simple answer to estimating the progressivity of our tax system based on incidence and dead-weight loss, and it depends on who does the calculating. There are some great examples of where differences between incidence and accounting lead to some eye-opening anomalies, including:
- The luxury tax on yachts Tom mentioned above fell disproportionately on boatbuilders, their workers and their local communities;
- The economics of mortgage interest deductibility suggests a transfer of wealth from LOW income renters and first-time home buyers to HIGH income homeowners with big mortgages.

Eric Krieg writes:

>>Do you really believe that just because Krugman never wrote a column about something, he doesn't understand it?

Who said that Krugman never wrote a column about the estate tax?

The man ADVOCATES THE ESTATE TAX! He just IGNORES the issue of who really pays it.

Eric Krieg writes:

>>Taxes are political, but who actually bears the burden of the tax is an economic question.

This is a naive statement in the extreme. I agree that the mechanics of determining tax incidence is not political. But the use of that information certainly is. To make a distiction between the two seems to me like you are just splitting hairs.

Again, I take you back to comparative advantage. It seems to me like CA is settled economics (Krugman even writes that CA is true). Yet there is perhaps no more political issue than CA, as we saw in the Schumer/ Roberts piece. It is not political in the Democrat/ Republican sense, but it IS political.

Tom Dougherty writes:

Are you telling me the intended targets by Congress of luxury yacht tax was actually the workingman and not the rich or are you saying there is a trivial distinction between the intended targets (the rich) and whom the burden of the tax fell upon (the workingman)?

Splitting hairs? To make a distinction between the intended targets and the actual targets is just splitting hairs? The difference between the rich and the workingman is a trivial distinction?

“To make a distiction between the two seems to me like you are just splitting hairs.”

Now that is a naïve statement in the extreme!

Boonton writes:

Who actually does pay the estate tax?

Eric Krieg writes:

>>Are you telling me the intended targets by Congress of luxury yacht tax was actually the workingman and not the rich or are you saying there is a trivial distinction between the intended targets (the rich) and whom the burden of the tax fell upon (the workingman)?

No, I'm not saying that at all. Neither were you in your original statement.

You said that the determination of who actually pays the tax is a non-political excercise. I agree as far as that statement goes.

But the implications of that determination ARE political, as your example shows. People forget just how USEFUL the fallout from the luxury tax was to Republicans back in 1994. They ran on the repeal of the luxury tax, among other things. It was one point in the contract with America.

That's why I think that saying that the tax incidence is not political is splitting hairs. Technically, perhaps you are right (but even there I think Boonton might give you an argument). From a practical standpoint, you couldn't be more wrong.

Eric Krieg writes:

Because the estate and gift taxes are taxes on capital, part of their long-run burden is likely to be shifted to workers through a reduction in wage rates [This part] is therefore likely borne by ordinary workers who never receive a bequest or taxable gift.

Boonton writes:
Of course tax incidence is political. If it weren't we wouldn't have capital gains and estate taxes. What is stupid is to say that tax incidence isn't political.

Now you mention that 'part' of the burden falls on wages. Key word there is part. It doesn't follow that capital gains and estate taxes should be eliminted in favor of wage taxes simply because part of their burden may indirectly fall on workers.

Boonton writes:

http://frwebgate3.access.gpo.gov/cgi-bin/waisgate.cgi?WAISdocID=5220586486+0+0+0&WAISaction=retrieve

BTW, the Economic Report places the burden of the estate tax mostly on heirs...not wages.

Lawrance George Lux writes:
How does the issue of economic incidence of taxes affect calculations of the progressivity of the tax system?

There is legal incidence, tax incidence, tax impact, and Comparative Advantage. Determination of progressivity of taxes always results in alteration of the legal incidence, and changes the three latter. Some would say tax incidence and tax impact are identical, they are not! Tax incidence is the exact placement where the tax is paid. Tax impact is the economic effect which the tax has upon who. Comparative advantage is who gains, or who loses by the placement of the tax. There has also been claim of a 'deadweight loss from taxes' is later comments.

The deadweight loss from taxes is actually hard to prove; Taxes pay for Infrastructure costs, provide for efficient Business contracting and service, and help support Consumer Demand and Consumption through Welfare transfers. Many Economists would deny the later benefit, but I would suggest they immediately advocate the dismissal of Social Security and Medicare at such a point.

Tax incidence varies adversely with the growth of Exemptions, Deductions, and Tax Credits. These all negate the natural selection of taxation based upon largesse of Income. The usage of such above a mandatory minimum effects the greatest malignment of tax impact.

Most of Arnold's piece actually concerned tax impact. He, and many Economists, do not understand the Comparative Advantage of tax incidence. Taxes can be advantageous because of their tax incidence, even though the tax impact is shifted. Take the Case of lower Wages for Workers because of Capital Gains taxation: Employers cannot shift such taxes effectively, because of Labor demands for a living wage. Employers must endure a competitive market for labor. The Capital Gains tax, though, reduces the tax impact upon those same Workers from other forms of taxation, plus all other Workers non-affected by the Shift; these Workers find they can increase their Consumption schedules--which fuel the Economy.

Tax impact is vital to determination of the legal incidence of taxes, but tax incidence is equally as important as regulatory mechanism of the Economy. Establishing the actual Payee of the taxes, sets the form in which tax transition is conducted. lgl

Eric Krieg writes:

>>It doesn't follow that capital gains and estate taxes should be eliminted in favor of wage taxes simply because part of their burden may indirectly fall on workers.

Hmm. That seems to be an awfully political calculation. I guess it depends on if you are one of those workers having your wages suppressed or not.

Boonton writes:
Hmm. That seems to be an awfully political calculation. I guess it depends on if you are one of those workers having your wages suppressed or not.

The 'suppression' does not occur in a vacuum. If the capital gains tax is eliminated, then what will replace it? Increased wage taxes? Increased gov't debt? Does the so-called trickle down mechanism guarantee that the 'incidence of benefit' from those who are the legal beneficaries of the tax cuts will offset the costs to wage earners of the alternatives?

Eric Krieg writes:

Boonton, you are making my point. IT IS A POLITICAL DECISION! You have to make the political determination of WHO PAYS THE TAX.

Bernard Yomtov writes:

What is the point here? Whatever level of government spending you think is appropriate, the money has to come from somewhere. The quoted section seems to ignore this, suggesting that capital income taxes be reduced without explaining what will be substituted.

Most likely the substitute will be increased taxes on labor. Hard to see how that is going to make workers better off. Of course that's not going to happen right away. Bush will borrow the money as long as he can. But when it's time to pay it will come out of wages, not capital. Great plan.

Eric Krieg writes:

>>But when it's time to pay it will come out of wages, not capital. Great plan.

Do tax rates actually have to be raised? If wages rise, then more income tax is collected.

What value is there to eliminating the dead weight loss of these taxes? What portion of the increased economic growth that will result from the elimination of the DWL will come back as other tax revenue?

The only way that I can see the US competing with India and China is if our economy becomes a heck of a lot more efficient. This means eliminating a trove of dead weight losses: excessive tort costs, inefficient public schools, our expensive health care system, and, yes, our horribly complex federal tax system.

Bob Dobalina writes:

Wow. I was familiar with the concept, but not with the names, and the data.

This was a great post, Arnold-- It certainly educated me.

Tom Dougherty writes:

The comments seem to be suggesting why not tax capital if the reduction in revenue is made up by increased taxes on wages. The benefits to wage earners through increased capital accumulation are small compared to increased taxes. I certainly see the point. But taxes on wages are paid by all type of people: rich, middle class, poor. The poor especially have to pay not income taxes so much as payroll taxes for entitlement programs.

But a middle class or poor worker might benefit from a capital gains tax reduction that led to increased capital accumulation and tools in the work place to enhance worker productivity in exchange for increased taxes on wages for upper income brackets. The top 50% of the income bracket pays 96% of all taxes anyway. It is certainly conceivable that a capital gains tax reduction could benefit low wage earners at the expense of high wage earners.

For those who, like Bob Dobalina, may be intrigued by the shifting of tax burdens, let me recommend one of the finest and most thorough summaries ever written on the subject: Charles F. Bastable's Public Finance, Book III, Chapter 5:
http://www.econlib.org/library/Bastable/bastbPF18.html#Bk.III,Ch.V

It may be no surprise that Adam Smith was the first to see the generality of this subject of how the person legally assessed a tax may not end up bearing the burden. Price changes occur as a consequence of every tax, and those changes "pass on" the tax burden to others in surprising proportions. It took till the end of the 1900s to work through those proportions and tax incidence in detail, in part because a clear dissection of supply and demand required the improved, precise framework made possible by the mathematical expositions and marginal analysis developed at that time.

dsquared writes:

While tax incidence is indeed a fascinating subject, I hope that nobody reading this is fooled into believing that it's "good for the workers" to have lower estate taxes and higher income tax.

Bernard Yomtov writes:

"Do tax rates actually have to be raised?"

Well, taxes do. We are looking at a deficit of maybe $650 billion this year, and no reasonable hope of having it come down significantly in the future.

At what point exactly we turn into Argentina I don't know, and I don't want to find out the hard way.

Eric Krieg writes:

>>Well, taxes do. We are looking at a deficit of maybe $650 billion this year, and no reasonable hope of having it come down significantly in the future.

Don't pull a Krugman here and exagerate. If you are fair, you will admit that the deficit comes from 3 sources. The biggest source is the recession. The second biggest source is increased spending. The 3rd biggest source is the Bush tax cuts.

We may need to raise taxes in the future. However, no tax increases should be on the table unless the Democrats highlight the spending programs that they are willing to cut. There should be twice as many spending cuts as there are tax increases.

And none of this should happen before there is 3 or 4 quarters of solid jobs growth (150K+ jobs per month).

Some of the increased spending is due to all the layoffs. You would think that a solid jobs recovery would help cut federal spending in and of itself.

Bernard Yomtov writes:

"no tax increases should be on the table unless the Democrats highlight the spending programs that they are willing to cut."

I don't think I'm exaggerating. The budget projects a deficit of $500 billion and, as lots of people have noted, omits a number of major items totalling roughly $150 billion.

So where does this deficit come from? The recession? I thought it was long over, and GDP was increasing. Increased spending? Maybe, but it's hard for me to see how the Democrats can be blamed for this. The Republicans hold the White House, the Senate, and the House of Representatives. If you think spending is out of control and you want to blame one party, shouldn't you blame them?

And of course the tax cuts do contribute a big chunk, and Bush wants to expand them. Doesn't he have a responsibility to say what he wants to cut?

But regardless of sources, it is unarguable that we have a huge deficit, and that it needs to be confronted, the sooner the better.

Eric Krieg writes:

>>If you think spending is out of control and you want to blame one party, shouldn't you blame them?

I do blame them. But I think that, if a consensus is built that the deficit must be addressed, the Republicans WOULD cut spending.

And I think that the Democrats would scream bloody murder when they did it.

A great deal of the increased spending was due to Bush's "New Tone", his attempt to give Democrats what they want on spending in order to get what he wants elsewhere.

I would have to say that the New Tone is a compelte and utter failure.

For what it is worth, I think that the Alternative Minimum Tax is going to take care of the need for tax increases. It isn't indexed to anything (inflation, incomes, or otherwise). Every year more and more people fall under its authority, 3 million people paid it last year.

I don't think that that is neccessarily bad. It is a relitively flat tax, and the rate is only 26%.

Bernard Yomtov writes:

"I think that, if a consensus is built that the deficit must be addressed, the Republicans WOULD cut spending."

What sort of consensus are you looking for? The first question is whether there is a problem. If so, it is the responsibility of the President to build a consensus to address it. It also becomes the responsibility of the President, and other political leaders (yes, both parties), to deal in facts, not fairy tales. That's part of what leadership is.

Churchill didn't say the Nazis would go away if the British just threw a few rocks at them. He asked for "blood, toil, sweat, and tears." Bush tells us to go shopping.

"And I think that the Democrats would scream bloody murder when they did it."

Probably. Just like the Republicans scream bloody murder when a tax increase is suggested.

Eric Krieg writes:

Bernard, I am saying that there isn't a consensus against the deficit. Please click on the link and take a look at one perspective on the deficit.

The link shows (through economic modeling) that there is a tradeoff between the deficit and the unemployment rate, at least in the short term. Anything you do to lower the deficit is going to raise unemployment.

Now, I don't think that ANY politician is going to make that tradeoff, Democrat or Republican. I'd be very surprised if you disagree.

As for Republicans raising taxes, I think that they got burned by the Democrats on that before. Poppy Bush cut a deal with the Democrats in '91, to raise taxes in return for spending cuts. The Democrats double crossed him and never made the spending cuts after the tax increases.

Bernard Yomtov writes:

Eric,

there is a tradeoff between the deficit and the unemployment rate, at least in the short term.

The key words here are "short term." Bush's tax cuts are not short term recession fighting cuts. They are permanent cuts of the sort that are least effective at stimulating demand.

Eric Krieg writes:

>>They are permanent cuts of the sort that are least effective at stimulating demand.

Are you sure about that? Tax cuts need to be permanent if you want people to spend the money rather than save it.

Don't forget my argument. You contend that there needs to be tax increases in the future. I say that there will be tax increases in the future, as more and more people pay the AMT. All that you will do by making the tax cuts permanent is increase the number of people exposed to the AMT.

I'm okay with that. People who generally get caught by the AMT are people with big mortgages and high state and local taxes. It seems to me that these deductions should be phased out for the wealthier among us (why do the rich need a housing subsidy?), and that is what the AMT does.

Eric Krieg writes:

Bush has proposed that the tax cuts become permanent. They haven't actually become permanent. As far as the public knows, they are short term tax cuts, and they should be performing that way, as far as you Keynsians are concerned.

I don't mean to sound like a broken record, but...

AMT. AMT. AMT.

The business magazines are going on and on about how many people pay it, supposedly middle class people. The more people it hits, the more revenue it brings in, the better off the deficit is.

I probably would be so hot on the AMT if I actually paid it. I checked when doing my taxes this year, and one more kid (one more child tax credit), and I will. But it wasn't a huge tax hit for me, and it wasn't hard to calculate (Turbotax did it for me), which is the two big complaints against the AMT.

Bernard Yomtov writes:

So the responsible Republicans can't do anything about the deficit because:

1. If they try to cut spending the Democrats will "scream bloody murder."

2. They can't raise taxes because, according to the official line from NRO or somewhere when Bush I did it he was double-crossed by the Democrats.

So, even though the Republicans control the government, even though they are the ones who put through the tax cuts and want more, even though they could reduce spending if they wanted to, still, you are convinced it's all the Democrats' fault.

Furthermore, even though Bush has been talking about making the cuts permanent since they passed, no one has caught on, and everyone is acting like they are short term.

Furthermore, the AMT will save us.

OK Eric. Whatever.

Eric Krieg writes:

The AMT will save us. Mark my words. It is the one wild card that isn't being included in all the analysis of the future deficits. I think it is ignored because people feel that it will be reformed before too long (that is the consensus of the business magazines).

Spending and the deficit will be taken care of in due course. Don't make the mistake of linearly projecting today's problems into the future. I think that if the deficit is really $500+ billion this year, and if job growth starts to kick in, there will be spending cuts. Maybe even some "targeted" tax increases (closing of some token loopholes).

Eric Krieg writes:

>>Furthermore, even though Bush has been talking about making the cuts permanent since they passed, no one has caught on, and everyone is acting like they are short term.

Look, you're the Keynsian, the one who thinks that short term tax cuts boost the economy. The tax cuts, as of this minute, expire in 2011. It seems to me that that meets the Keynsian definition of short term stimulus.

Bush can talk all he wants about making them permanent. The likelihood of them becoming permanent is less than 100%. With the deficit as high as it is, maybe it's 50-50 at this point. Maybe less. It depends on how big he wins in Nov. (if he wins).

Just like a Democrat to change the rules of the game to suit the debate.

Eric Krieg writes:

>>even though they could reduce spending if they wanted to

Where would you cut spending? Try coming up with cuts that might work politically. Don't say farm subsidies, because we all know that is not going to happen.

Coming from this as a Republican, I don't see where spending can be cut. Every dollar has a political supporter. There has to be serious fiscal problems (like a trillion dollar deficit, for example) to get over that political hump.

Bernard Yomtov writes:

"I think that if the deficit is really $500+ billion this year, and if job growth starts to kick in, there will be spending cuts."

I think the deficit will be closer to $700 billion than $500 billion.

"Coming from this as a Republican, I don't see where spending can be cut. Every dollar has a political supporter. There has to be serious fiscal problems (like a trillion dollar deficit, for example) to get over that political hump."

Even if the deficit is over $500 billion? How do you square this with your previous comment?

So are you saying you think the only hope is the AMT? I think you discount the likelihood of reform far too much.I agree with the magazine consensus. What do you think is going to happen when tens of millions of households suddenly have to pay this new (to them) tax? I think it will be changed in a heartbeat.

"Tax cuts need to be permanent if you want people to spend the money rather than save it."

My impression is that the empirical evidence does not support this idea.

And a tax cut that expires in 2011 is hardly "short-term."

Eric Krieg writes:

It seems to me that the economy is pretty good right now, except for 2 things:

1) payroll growth

2) the federal deficit

You could probably add the trade deficit to that list, but the faling dollar will take care of that in due course.

Now, in the near term, there is a tradeoff between unemployment and the deficit. The only way that any politician is going to cut spending and raise taxes is if there is jobs growth, or if the deficit gets to really obscene levels. $500 billion isn't obscene, it is merely large.

I really don't think that the AMT is going to be reformed. That would be a "tax cut for the rich". At this point in time, with politics in Washington the way they are right now, I don't see it changing.

Eric Krieg writes:

My thinking on the deficit and taxes parrallels Martin Feldstein, more or less...

http://www.opinionjournal.com/extra/?id=110004701

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