It would be utterly impossible to trace the burden of every tax until the incidence were definitely determined. In fact, it would be impossible to trace definitely, through all its ramifications of direct and indirect influences, the shifting of any tax burden, though it could be much more nearly done in some cases than in others. Some taxes are not shifted at all, others to a very small extent, while the burden of some is lost in the great mass of a consuming population where it is impossible, sometimes, even to locate or estimate the burden.
The Diffusion Theory. - The difficulty of tracing a tax, however, need not discourage a study of the principles which underlie the conditions which make shifting possible. An early group of theorists held that every tax was shifted on and on, ad infinitum, until the burden rested upon every individual. This is known as the diffusion theory, and was supported because it was believed that taxes were so diffused that the amount which fell upon any individual was so small as to be practically burden-less. A moment's reflection, however, will reveal the fallacy of such reasoning.
Suppose an individual buys a suit of clothes for his own consumption, for which he pays $50. There is a 10 per cent tax on the excess paid over $25, or a tax of $2.50. Since he does not pass the clothes on to some one else, and thereby provide the possibility of raising the price to $52.50, in order to recoup himself, he must bear the burden. Numerous taxes, such as the one suggested, are familiar to those who bought goods during and after the Great War. If, in the supposed case, however, the tax had been placed on the manufacturer, and he had raised the price $2.50 to the wholesaler, who likewise raised it $2.50 to the retailer, the consumer must pay $2.50 in order to recoup the retailer. The incidence in this case is the same as in the first supposition, although there have been a number of shiftings. But the consumer cannot shift the tax farther. The suit of clothes is now past the final stage of production, and has ceased to influence the producer-consumer relationship. It no longer can enter into demand and supply as it did when in the hands of the retailer, wholesaler, or manufacturer.
Demand, Supply, Price. - From this example it is seen that a tax on a good cannot be shifted by the consumer if it is levied after the last stage of the productive process. In other words, there must be a chance to affect an increase in price to some one else in order to regain the tax. It is a truism to economic students that the two most active determinants of price are supply and demand. In order to influence price, then, the individual who wishes to shift a tax must do it through influencing one of these factors. The case would be rare where a good would be more in demand after a tax had been placed on it than before, for it is difficult to see how the circumstance of a tax would increase the utility. It might be true in cases where the use of taxed goods gave some mark of distinction, and therefore made them desirable, but such cases would be so rare as to need no consideration.
Ordinarily, then, the price change must be effected through a change in the supply. A decrease in the supply, with a constant demand, will raise the marginal utility, hence increase the price and allow the tax to be shifted. From this brief review of the nature of price it is easily seen that a study of tax shifting is fundamentally a study of the laws of price. With this in mind it will be interesting to note the possibility of shifting some of the more common taxes.