Wednesday, April 4, 2007

Who Pays Taxes: The Buyer or The Seller? The Employer or The Employee?

One or the other, sometimes both, sometimes none.

Here's a simple example: Say that you buy apples for 20 cents each, and sell them for 25 cents. Then, a 2-cent sales tax is applied. Two different things can then happen:

A) You can charge 27 cents per apple: 25 cents and a 2-cent tax.

B) Buyers might refuse to spend more than 25 cents per apple, so you lower the price to 23 cents, charge a 2-cent tax, and collect a total of 25 cents.

Depending on the buyers' willingness to buy apples at a high price, your willingness to sell them at a low price, and competition among apple sellers and buyers, the final price (including the tax) can be anywhere between 25 cents and 27 cents.

Here's where the real harm comes in: For whatever reasons (say, bad weather), you now need to pay 24 cents for apples, and must therefore charge 25 cents to make a profit. Now, let's say that people will pay a maximum of 25 cents, tax or no tax.

Question: Who will now pay the 2-cent tax?

You're already making as slim a profit as possible, so you have to "pass the tax along" to the buyers. But the buyers don't think apples are worth 26 cents. So: No deal. The apples go unsold, even though you are willing to sell them and people are willing to buy them at a mutually agreed-upon 25 cents.

So...who pays the tax? Regardless of what the law says about who will pay the tax, it will be paid sometimes by the seller, sometimes by the buyer, sometimes by the buyer and the seller, and sometimes -- when businesses are ruined -- by no one.

1 comment:

Anonymous said...

Too simplistic

The fact that the merchant can buy apples at 20c from the grower is simply a measure of availability, competition between growers and price elasticity.

The fact that the merchant can sell them for 25c to customers is a measure of the availability, competition between merchants and elasticity. There's nothing preordained about either price.

If bad weather made apples cost more from the grower then either the merchant would switch to another grower unless all growers would be affected by the bad weather. Either way the reduction in availability would (in a free market) drive up the grower selling price just as a glut would drive it down. Such a general movement may not be instant but it would occur. The scarcity from growers would therefore translate to a scarcity amongst merchants. Elasticity would determine by how much the market shrinks when prices rise. If a million apples are sold at 25c then 800,000 are sold at 28c, and 1.8m at 20c. Thus apples would still be sold.

The important point to note about tax (not just sales tax) is that unless there is no elasticity, any tax will negatively effect demand and thus reduce activity.