Tax incidence refers to who ultimately pays the tax, the producer or consumer, and the resulting societal effect.. Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately has to pay, the tax. The key concept is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply.
Inelastic Supply, Elastic Demand
If a producer is inelastic, he will produce the same quantity no matter what the price. If the consumer is elastic, the consumer is very sensitive to price. A small increase in price leads to a large drop in the quantity demanded .
Tax: Inelastic supply and elastic demand
In a scenario with inelastic supply and elastic demand, the tax burden falls disproportionately on suppliers.
The imposition of the tax causes the market price to increase from P without tax to P with tax and the quantity demanded to fall from Q without tax to Q with tax. Because the consumer is elastic, the quantity change is significant. Because the producer is inelastic, the price does not change much. The producer is unable to pass the tax onto the consumer and the tax incidence falls on the producer. In this example, the tax is collected from the producer and the producer bears the tax burden.
Comparable Elasticities
In most markets, elasticities of supply and demand are fairly similar in the short-run, as a result the burden of an imposed tax is shared between the two groups albeit in varying proportions .
Tax: Similar elasticity for supply and demand
When a tax is imposed in a scenario where demand and supply exhibit similar elasticities, the tax burden is shared.
In general, the tax burden will be greater for the group exhibiting the greater relative inelasticity.