Who pays taxes – producers or consumers?
Tamaz Akubardia
America has a two hundred years’ history of independence. It has had the mission of world leader for a hundred years already. No one pinned this mission on them. It deserved this right for the really high level of development.
The present-day level of development in America causes everybody’s admiration. And it was even more surprising when the congress of the country passed a law in 1990 on surcharging luxury goods. This very congress of America with the State machinery consisting of economic experts (including he Nobel Prize laureates) and with research institutions has passed a law on surcharging luxury goods.
A list of luxury goods was quite impressing and it included: private planes, yachts, fur coats, valuables, prestigious cars and many other things. The reason for passing this law is quite clear and simple at first sight – surcharge of the most well-off in the country with the purpose of redistributing tax burden among the citizens with comparatively low taxes. There was no doubt that the burden of these taxes would lie with the richest layers of society. Will a poor man buy a plane, yacht, etc? What on earth does he need it for? I would like to repeat again that all this took place in America some 10-11 years ago, in the country where economic potential not to mention its scientific and technical potential, causes everybody’s delight. And what could we say about Georgia where transition to market system has only a ten years’ long history?
Let us consider this question in detail. I insist on its detailed consideration because it is still a novelty to us.
Let us first speak about a tax paid by a buyer. The clearest example of this tax is VAT (I would like to make the following comment here. The abbreviation “VAT” is a test for examining those wishing to come to economic bloc. This test shows whether they can think in accordance with economic categories or not. If one says “surplus value charge” instead of “value added tariff”, i.e. if he uses the word “surplus” instead of added, we can conclude that he either does not think in accordance with economic categories and, therefore, he is a bad economist, or it is one and the same to him).
Let us consider the following hypothetical example. Let us assume that the well-known soft drink “Borjomi” is liable to tax that obliges each citizen pay 20 Tetri per bottle. How will this tax effect a buyer or seller? See diagram 1.
First of all, the tax will effect demand for this drink, the supply curve will remain unchanged because seller of “Borjomi” does not have any stimulus or reason for changing the quantity. Apart from the price for each bottle, a buyer must pay tax to the state. Therefore, if we consider demand and supply curves, the supply curve will remain unchanged (will not move) whereas the demand curve will move. Determining the direction of this move is quite easy. Of course, the surcharge will serve to reduce the number of those wishing to buy “Borjomi”. As a result of it, the demand will move to the left. In a concrete situation one can more or less determine the exact direction of demand curve.
In our case, we can use this line of reasoning: 20 Tetri was added to the price of “Borjomi” (it cost 1 Lari). The buyer must pay this tax. Its real price for the buyer made up 1 Lari 20 Tetris, i.e. 20 Tetris more than market price. It does not matter to the buyer whom he should pay – state or entrepreneur. The main thing now is that he has to pay 1 Lari 20 Tetris instead of one Lari as before. In order to keep demand on the same level, we will have to bring down the market price of “Borjomi” by 20 Tetris. Then the effect of the tax will not be so obvious.
In order to determine the tax effect, we must compare initial and present balance. The equilibrium price of “Borjomi” reduced from 1 Lari to 95 Tetris, the balanced quality reduced from 100 bottles a year to 90 bottles a year because in the conditions of new balance seller sells less and the buyer buys less. Therefore, the surcharge of “Borjomi” leads to the reduction of both the equilibrium price and the realized production rate.
Let us now try to answer to a seemingly easy rhetoric question. Who must pay this tax?
Despite the fact that buyer pays this tax in corpore, the tax burden will lie with both seller and buyer. The buyer pays the seller less (95 Tetris), the seller pays 15 Tetris more for the bottle and buys less than 10 bottles. At the same time, the real price of the bottle has increased by 20 Tetris (95+20Tetris=1.15).
Let us consider another case. Let us assume that now the seller has to pay the state 20 Tetris per bottle. What will it result in?
In this case, reduction of tax will effect the supply of “Borjomi” because the tax does not concern the buyer. The demand for “Borjomi” remains unchanged no matter the price. As a result, the demand curve will not change.
On the other hand, the tax burden is placed on the seller. Therefore, he has to reduce the supply quality of “Borjomi”. As a result of it, the supply curve will move to the left and then to the top.
The value of the curve move can be defined in the same way. The real market price for the seller of “Borjomi” is 20 Tetris less than before.
At the same time, no matter how high the market price is, the seller provides the buyer with the same quantity of “Borjomi” as before when its price was 20 Tetris less. In other words, the seller must sell “Borjomi” by 20 Tetris more in order to gain the same profit. Tax effect will become balanced only in this case. If the market is competitive, the price of “Borjomi” will increase by 1.15 GEL. The quantity of sold bottles will reduce from 100 to 90 bottles.
In this case, the new tax will reduce the market scale so that the burden will lie with both the seller and the buyer. Because of the rising market price, the buyer pays 15 Tetris more for “Borjomi” and the seller formally gains more profit than before the surcharge, but the real price (after paying the tax) will reduce from 1 Lari to 95.
The important thing is who is obliged to pay the tax – seller or buyer. From the viewpoint of results, the both cases are equivalent. That is to say, because of the tax charge, the price paid by the buyer is different from that of sellers’. Here, it is not important who pays the tax – buyer or seller. In both cases, the tax burden lies on both of them.
In order to understand this well, let us imagine that the state collects taxes by means of a basket that is fixed in the shop “Borjomi” i.e. when the state obliges the buyer to throw 20 Tetris into the money box. When the seller is obliged to pay tax, he throws 20 Tetris off each sold bottle. Thus, it is all the same to the government who will throw 20 Tetris to the money basket. The main thing is that the tax burden should be equally distributed between the seller and the buyer. As far as distribution of tax burden is concerned, it is very easy to answer this question if you know what is elasticity.
Elasticity means that the seller and buyer is ready to leave the market only if the terms do not suit them. Small elasticity of market means that the seller has no alternative for producing a particular product (see diagram 4).
When commodity is taxed, the party that has small alternative can not leave the market easily. As a result, a great tax burden is imposed on it. Therefore, the tax burden lies with the party that has less elasticity.
Let us now consider the law “about taxation of luxury goods” passed by the Congress in 1990.
The above-mentioned point of view about the distribution of tax burden between the seller and the buyer opposes the populist decision of the Congress. True, if we consider the market of yachts, the demand for them should be elastic. A millionaire can easily give up the idea of buying a yacht, f.e. as a sign of protest against the above-mentioned law. As far as the production of yachts is concerned, i.e. supply – it should become inelastic. Producers of yachts can not easily abandon production of the yachts and launch a new business. Strange as it is, on account of demand elasticity and supply inelasticity, the tax burden will lie on yacht producers, but not on millionaires.
Therefore, the great part of tax burden lies with middle class, but not on millionaires. Groundlessness of this economic policy became obvious after it came in force and producers have faced great difficulties with the product realization. In 1993, the Congress abolished this law.