The burden of the tax can be transferred to others through a process of shifting. It may be noted that the whole burden of the tax may not be shifted to others. It may be that a part of the tax may be shifted to others and a part be borne by the one who initially pays the tax.
As a matter of fact, a part of the tax burden rests on all the persons to a larger or smaller degree in the chain of transferring the burden so that at the ultimate end only a small burden rests. The process of shifting the burden of a tax goes on so long as different persons who come in the chain are able to pass on the burden to others till it ultimately rests on a person or a group of persons who cannot shift this unwelcome baby further.
Theory of incidence of tax studies in what proportion the burden or incidence of a tax is shared among different persons. It may be noted that a tax can be shifted through a process of exchange or, in other words, an individual or a firm can shift the burden of the tax if there occurs exchange relations which are conducted on the basis of prices of goods and factors.
The person who initially pays the tax can pass it on to the other either in the form of higher prices of goods he sells or in the form of lower prices of factors he buys. Whether shifting can take place or if it does so how much tax burden can be shifted depends on a number of factors.
- The Nature of a Tax:
The nature of a tax as to whether it is a tax on the production or sale of some commodities or it is a personal income or property tax. Tax shifting can easily take place in the case of taxes on the production and sale of commodities. The taxes on production or sale of commodities are called indirect taxes. The important examples of indirect taxes are excise duties and sales tax. On the other hand, the burden of direct taxes such as income and wealth taxes cannot be shifted.
- Market Conditions:
Whether commodity is being produced under conditions of perfect competition, monopolistic competition or monopoly goes to determine the extent to which the burden of the tax can be shifted. A monopolist who has a full control over the supply of a commodity is in a better position to shift the burden of a tax on the commodity produced.
Likewise, a producer working under monopolistic competition who produced a product somewhat different from others exercises a good deal of influence over the price of its product and therefore can pass on a part of the burden of the tax to the buyers.
Even the firms working under perfect competition can shift the tax burden as the tax levied on a commodity raises its supply price for all of them. The difference in the three market forms lies in the extent to which the burden of the tax can be shifted.
- Physical Conditions of Production:
The shifting of the tax burden on a commodity also depends upon whether the commodity is being produced under increasing, constant or diminishing returns. This will be explained in detail a little later.