Tax Incidence

Tax Incidence Theorem: The economic burden of a tax is shared between buyers and sellers regardless of who legally pays it. The split depends entirely on relative elasticities. Incidence on buyers = εₛ/(εₛ + |εd|) and on sellers = |εd|/(εₛ + |εd|). When demand is perfectly inelastic (εd→0), buyers bear 100% — they cannot reduce purchases. When supply is perfectly elastic, sellers bear none — they exit if price falls. Deadweight loss (Harberger's triangle) = ½ × tax × ΔQ represents value destroyed by the distortion. Minimizing DWL: tax goods with low elasticities (Ramsey rule).