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In Europe, shop prices are typically displayed including VAT. This gives the impression that the seller is paying the VAT. They have to offer a competitive price, then a percentage of that is taken out as tax. But, if VAT didn't exist, sellers could offer a lower price. So in another sense, buyers pay the tax.

In the US, sales tax is typically added at the till. This makes it feel like the buyer is paying the tax. But ultimately, VAT and sales tax are the same (at the point of final sale) - does it really make a difference how the prices are displayed?

The same issue exists with income tax, stamp duty, and presumably many other taxes. It's quite integral to Western life that income tax is paid by the employee - you hear people say "I pay my taxes, I'm part of this society". But the need to pay income tax means that employers need to pay higher wages, so the employer is bearing the cost as well.

Does it make a difference what happens when the rate changes? For example, if income tax rises, typically salaries do not rise to match. But if sales tax rises, the the amount added at the till immediately rises too.

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    $\begingroup$ One interesting point is that the form of tax collection (and sometimes simply how it is named) can significantly affect such things as tax rebates for exports, deductability of the tax from taxable income, etc. $\endgroup$
    – Hot Licks
    Dec 19, 2017 at 0:46
  • $\begingroup$ I'd debate the premise that European consumers think the seller is paying the VAT. In the UK everyone I know thinks of it as an extra cost that they pay. This is also not correct cf. price elasticity, but including it in the marked price means it's not so in your face. I imagine that if every transaction costs more than marked, as in the US, it might stoke individuals' resentment of the tax system. $\endgroup$ Mar 29, 2023 at 9:35

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The issue you are asking about is tax incidence. This Wikipedia entry provides a good introduction. In short: it depends on how easily supply and demand respond to price changes relatively to each other, the so called price elasticity of demand and supply.

According to standard theory, it doesn't matter who pays (in the legal/fiscal sense) the taxes, as the burden of the taxes depend on economic circumstances. If demand falls rapidly with higher prices while supply does not, sellers/producers will lower their price (before tax), and therefore carry a relatively large part of a tax.

Of course, there may be all kinds of administrative costs and other 'frictions', that make it more or less efficient to have one group or another pay taxes. Also, there is evidence that people do change their behavior according to how the taxes are paid; see for example this paper, or this document.

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    $\begingroup$ Should this not note which "standard theory" this follows? Does this not fall under Keynesian, Austrian, or another theory type? $\endgroup$
    – LabGecko
    Apr 22, 2019 at 16:12
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The primary difference between VAT and sales tax is not whether the buyer or seller pay the taxes. Rather, the primary difference is that sales tax basically repeat-taxes every step of the production process. If coal is used to make steel, which is used to make beams, which is used to make a building, the value that the coal added to the steel is taxed 4 separate times. Because of this, sales tax creates a perverse incentive for businesses to inefficiently vertically merge. VAT eliminates this repeat taxation.

In a perfectly competitive market where sellers are simply price-takers, the burden of the tax is born by the ultimate buyer in the form of higher prices (exactly as much higher as the tax is), and the industry will sell fewer in total because of the higher price. However, in a more monopolistic scenario, the price does not go down as much as the tax is, and the burden of the tax is split more with the seller. The usual case is somewhere in between.

I wrote more about this here.

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    $\begingroup$ Thanks. Your blog looks interesting, I'll have a read when I have a bit more time. I'm not sure what you say about sales tax is right though, it's usually only paid by the final consumer - and defining exactly who is a final consumer and what is B2B is one of the tricky parts about implementing it. $\endgroup$
    – paj28
    Jul 24, 2023 at 9:19
  • $\begingroup$ You're correct that the burden of sales tax is usually born mostly by the final consumer. Tho I think its somewhat simplistic to even think about these things as "who bears the tax" - really the whole economy bears the burden. Even with sales tax, the tax is passed on to the end consumer, who then has less money to buy more things, which means industry sells less, leading to a higher price, etc etc. The economy is cyclic and we all bear the burden of taxes. The more important question is how do taxes affect incentives, not who bears the burden. $\endgroup$ Jul 24, 2023 at 21:07

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