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Frequently a description that is clear in the mind of its author is not as clear to a reader. It is even worse when the reader finds the description clear but actually misunderstands the intention of the writer.

There are many such descriptions in economics. As social animals, economists learn from each other and copy each others phraseology - if I understood it, it is probably clear. However not all widespread phraseology is clear. A good example is in cooperative game theory, where Lloyd Shapley wrote a note titled 'Let's Block "Block"'. (If you read it be sure to read the footnote as well.) Shapley was among the originators of the phrase 'block' as used in cooperative game theory. But 'blocking' was actually a precisely defined mathematical concept in the science and as events unfolded it became clear that in some cases the popular meaning of the word conflicts with mathematical definition, resulting in Shapley's note.

After this introduction I will state my questions.

  1. Is it correct and/or useful to say that in a market where a per unit tax (or quantity tax) is levied on the good the suppliers push part of the tax onto the consumers?
  2. Is it correct and/or useful to say that in the same situation consumers and suppliers share the tax burden?
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(1)

A unit tax increases a firm's marginal cost and causes it to reoptimise its price/quantity decision, usually with the result that acquiring a unit of the good becomes more expensive for consumers. But this is just one manifestation of a more general phenomenon. The partial equilibrium effect would be the same if a technological or other exogenous shock caused the firm's marginal cost function to shift.

In my mind, this proper terminology for this kind of dynamic is cost pass-through. My preference would be standardisation around a single, well-defined term. Some headway has already been made in this process.

I would favour avoiding expressions like "the firm passes costs through", because this might give the misleading impression that the firm is taking an active role by increasing its price. But we know that in some models firms do not set prices. It therefore seems appropriate to use the more passive expression "costs are passed-through".

(2)

I find this terminology more useful. In particular, there is a difference between paying the tax (by which I mean actively making a remittance to the government to fulfill a tax obligation), and bearing the burden of the tax (meaning that your surplus/profit decreases as a consequence of the tax). The tax is paid by the firm(s), but the burden falls on the shoulders of both firms and consumers.

The most important contribution of tax-incidence analysis in my mind is to make clear the (often counter-intuitive) idea that these two things are not the same. So having a succinct language to differentiate them seems to be of value.

My one reservation is that saying "consumers and suppliers share the tax burden" may be seen to implicitly imply that the entire social cost of the tax is bourne by consumers and suppliers. But this would neglect the fact that there is also a deadweight loss.

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I do have an opinion in these matters:

  1. Without further information about the market structure this phraseology is unclear and therefore its use is incorrect. An example:
    Suppose the supply side of this market is provided by a state run company. The company does not care about profit but does care about social optimum, hence they operate at the level where marginal cost is equal to the market price. Of course the government needs funds for other projects. (For public goods where the free market would not reach an optimal allocation.) Thus it levies a tax on other goods, also on the one in our example. This shifts the supply curve upward. Is the welfare maximizing state company really 'pushing the tax onto the consumers'? I would say no. The market mechanism was changed and the new equilibrium allocation is different. Yes, consumer prices are higher in the taxed equilibrium if we compare the two.
    Perhaps you find this example contrived. Another objection I would raise against the phrase is that in case of perfect competition companies have no price setting power at all, they are price takers. How is it then possible for them to push taxes? Again, I think the market mechanism is changed, and this changes the equilibrium price and quantity.
  2. In almost all cases this phraseology is unclear and therefore its use is incorrect.
    In the UK in May 2016 the Alcohol Duty payed on alcoholic beverages was 852 million pounds. I would argue that this tax is levied on the suppliers of the beverages. Of course consumers are made aware of the tax and suppliers use the money payed by consumers to transfer to the treasury but consumers transfer exactly 0 million pounds to the treasury under the heading Alcohol Duty. The other approach where we estimate a demand and supply curve and calculate the equilibrium price without the Alcohol Duty and compare this to the price consumers pay and the price suppliers get with the duty would yield a different outcome. But this obfuscates matters greatly. Again, what happens is that the market mechanism is changed. The duty raises the equilibrium price payed by the consumers and lowers the equilibrium price received by suppliers. Sometimes this phraseology also talks in welfare terms and mentions the tax burden. I find this somewhat better as both consumer and supplier welfare is decreased in this case. Usually however this burden is equated with the tax received by the state. This is generally incorrect as it does not take into account the deadweight loss caused by the tax. So while the tax does burden both consumers and suppliers just by comparing these burdens one does not get anything akin to who is paying what share of the tax. The market mechanism is changed by the tax. Comparitive statistics may be preformed to examine welfare changes. These concepts exist and are clear.
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  • $\begingroup$ A note: One might argue that in my first example for 1., the case of the state run company, the optimum condition would be unchanged if the company seeks a global optimum and not just a market optimum, i.e. if it considers the taxes it transfers to the state not just as a cost but also as a benefit. $\endgroup$ – Giskard Jul 17 '16 at 10:04

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