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• The burden of taxation cannot be answered without the knowledge of elasticity of demand and supply

• The person legally responsible for paying tax, need not bear the burden

• Seller, increases price by adding tax to current price

• Keeps price net of tax for himself

• If tax is imposed on buyer• Demand curve shifts• Part payment goes to seller, remaining to

treasury• Share paid by consumer and producer??• After tax price received by producer, has fallen

to the extent of per-unit tax• Figure 7.11 b

Tax/Subsidy capitalization

• Provides a convenient link between equity and efficiency concerns

• Figure 7.19• Overall market for assets• Market for given stock of asset H

• H exists in perpetuity, and offers annual return of Rs. 10,000

• If equilibrium rate of return is 10 percent• Capitalized value is 1,00,000• Tax of one percent (Rs. 1000) on asset H• H must conform to 10 percent return– How can this be achieved??

• Net annual return = Rs. 9000• Value of H=90,000• Tax is completely capitalized into the price of

H; all burden falls on owners• There is no allocative consequences

Large asset case

• Suppose a tax on H, which now is a large asset, is sufficient to reduce the net rate of return on assets

• D shifts• Equilibrium volume of assets decrease• Allocative loss created• What happens to price of stock??

• Value remains at 1,00,00; unchanged• Short run phenomenon• Complete or no capitalization- different effects

on equity and efficiency• Former is inequitable, but it is attractive on

allocation• The latter, statutory and actual incidence

coincide, equity is there, but no allocative efficiency

• Favourable tax treatment/subsidy• 2 percent• In case of small asset classification, the market

price will completely capitalize the favourable treatment, price will rise to 1,20,00 and return remains at 10 percent

• The owners of H are gainers

• Years later, this subsidy is withdrawn…what would be the effect???

• The value would fall• Subsidy not had any stimulatory effect on

supply of H• Windfall loss falls on those who did not reap

the windfall gain (unfair)