Perhaps the most misunderstood aspect of taxation is the answer to the simple question of who pays. Now, to simplify the issue, this has little to do with the tax rate. Rather, it has everything to do with who actually bears the burden or “incidence” of a tax.
To an accountant, the answer to the ‘who pays’ question is straightforward. Households pay income taxes, corporations pay corporate taxes, property owners pay property taxes and consumers pay sales taxes. The problem with this simplicity of understanding is that it is both terribly wrong, and terribly misleading. The statutory taxpayer is rarely the one who really pays a tax.
All taxes are ultimately paid by households, either directly to the government, or indirectly through changes to the prices or quantity of goods and services. It is probably easiest to start with the one tax that is most distortionary — payroll tax.
Payroll taxes comprise a flat collection, primarily for Medicare, Social Security and unemployment insurance. The biggest chunk is statutorily paid by businesses, with about 40 percent withheld from worker paychecks. That is what you see on your paystub each month under FICA deductions. The money to pay for these taxes comes from business revenues that would otherwise be paid in the form of wages, profits or other business expenses. The question isn’t about what is reported on the pay stub, but rather about which pot of money the revenues are drawn from. That is an economic question.
It turns out that the economic incidence of taxes is determined by the relative responsiveness of supply and demand to a price change. Economists call this elasticity. So, the less responsive an item is to a price change, the higher its share of any tax will be. As it turns out, labor supply is much less responsive than labor demand to a change in wages.
So, workers end up paying almost all payroll taxes through lower wages, not solely the share that is reported on their pay stubs. Also, because low-income workers have a less elastic labor supply, poor workers probably pay all the payroll taxes, perhaps 15 percent of their wages, while higher income workers’ pay a much smaller share.
Other obvious examples are property taxes on rental homes. In places with few rental properties and many renters, that tax can be easily passed on. So it is college students, not landlords, who mostly bear the cost of a tax through higher rents.
A great deal of research tells us that sales taxes on staple items are borne by the consumer, sales taxes on luxury items are felt mostly by the business owners, and income taxes are mostly paid by households. The most contentious tax is on corporations. As it turns out, corporate taxes, especially in high tax America, are largely paid by workers. All of this leaves economists chuckling. As it turns out, many naïve folks argue for higher taxes on corporations and property holders, thinking that this will be fairer. They couldn’t be more mistaken.
Michael Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University.