Not all taxes are alike. Some are very direct and open; others lead a sort of double life, partially visible, partially hidden. Discovering which is which often provides a “learnable moment.”
Taxes are very much in the news today. Our minds are filled with prospect of a federal income tax cut for middle class earners, tariffs raising prices for imported goods, rising prices squeezing household budgets and tax issues filling election ballots.
One good example of a tax with a double life is a tariff on imports. Recently, for example, tariffs have been imposed on several countries and areas by President Donald Trump as a negotiating lever to get rid of trade barriers that are unfair to the United States.
These recent tariffs were intended to be temporary so if negotiations are successful, as they have been with Canada and Mexico, with luck we will never see their full impact. That would be a good thing, for it is not unusual for a tariff to damage the economies of both the exporting and importing countries.
There are two useful perspectives on taxation: one, used in accounting, views a tax as a transaction and identifies the payer as the one who writes the check; the other, used in economics, views a tax as a transfer from the private to the public sector and identifies where in the economy the money ultimately comes from — in other words, who really pays.
Federal income taxes are direct and open; at least they are before Congress begins defining exemptions, exceptions and categories for special interests. What we have now is an income tax where individual taxes are generally direct and open and corporate taxes are a morass that is difficult even for experts to navigate.
Economists use the term “incidence” to indicate who really pays. In many cases both buyer and seller end up paying and incidence is used to calculate the amount or portion that each pay.
With a tariff, usually it is the importer of the goods that has the responsibility to pay the government. It is often the consumer who really ends up paying, though, because the importer must recover that cost increase through higher prices, suffer decreased profit, or stop importing the goods entirely. Those limited and unpleasant choices facing the importer and the consumer are the reasons why most economists are opposed to tariffs.
How much the consumer pays can be complicated, and very dependent on how both the supply and demand respond to the product’s price hike. It is, as you might expect, also dependent on the availability of substitutes for the product and the price hike’s impact on household budget s.
Another example of a tax with a double life is the proposed carbon tax. In the Washington state version of this tax, it appears to be a “tax on polluters,” which sounds like a good thing. But consumers will probably end up paying the lion’s share of this tax through higher prices for gasoline, heating oil and electricity.
It’s not quite that simple, of course, and the total effect of the carbon tax is difficult to estimate. For the consumer, the initial reaction to a price hike is usually minimal. The demand for energy is generally what economists call “price inelastic” — that is, relatively insensitive to price changes. It is more responsive to changes in disposable income.
If the price hike is substantial enough to bite into disposable income, or persists long enough, though, consumers often start to cut back consumption. They consolidate shopping trips and errands, they explore public transportation options and they may even join a carpool. And if the price hike continues consumers may swap their car for one that gets higher mileage or explore moving to another job or another location that would provide a shorter commute.
All is not roses for the supply side either. The energy companies will be facing lowered profits whether they pass the tax on to consumers — and face lowered demand — or pay it themselves. And they will be facing new demands for capital investment in their tanker fleets as the demand for natural gas rises in Europe.
Sorting out who pays and how much is not a simple process, and analysts will have to rely on experience to develop credible estimates. Only the government is the clear winner.
Taxes that lead double lives are not the most efficient way to transfer funds from the private sector to government, but they are often attractive in part because the incidence, the “who pays” issue, gets lost in the complexity and outshone by the stated, feel-good, goals. Voters have their work cut out for them in this fall’s election. Maybe it will help if they think of it as a “learnable moment.”
James McCusker is a Bothell economist, educator and consultant.
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