Who Bears the Burden of an Indirect Tax?

Both can bear the burden of an indirect tax. Consumers usually pay a higher price, while producers receive a lower price after tax. How much each bears depends on the relative price elasticity of demand and supply.

This is the incidence of a tax: how its cost is shared. In Cambridge International AS Level Economics, it falls under Methods and effects of government intervention in markets, point $\mathrm{3.2.1}$, which covers the impact and incidence of a specific indirect tax. A specific tax is a fixed amount charged per unit sold.

What determines the split?

An indirect tax raises a firm’s cost of supplying each unit, shifting the supply curve upwards. The new equilibrium has a higher price for consumers and a lower price received by producers after the tax is deducted. The gap between those two prices is the tax per unit.

The side that responds less to a price change tends to bear more of the tax:

• If demand is relatively inelastic, consumers buy nearly as much despite the price rise, so they bear more.
• If supply is relatively inelastic, producers cannot easily reduce the quantity they supply, so they bear more.

Price elasticity measures how responsive quantity is to a change in price. Compare demand and supply with each other; knowing only that demand is inelastic is not enough to determine the split.

Worked example

Suppose the original price is $10$ currency units. After a specific tax of $3$ per unit, consumers pay $12$, while producers receive $9$ after tax. Consumers bear $2$ per unit through the higher price; producers bear $1$ per unit through the lower amount received.

Exam mistake to avoid: Do not say producers bear the entire tax just because firms pay it to the government. Who remits the tax and who bears its economic burden are different questions.