Incidence is the final resting of a tax e.g. direct, tax incidence lies in every individual but in indirect taxes the incidence lies in the ultimate consumer, The modern meaning of incidence as introduced by Hicks is that incidence are changes in the income distribution brought about by changes in the budgetary policy i.e. changes in taxes and changes in public expenditure.

Taxation is important for the growth of an economy. However, not everybody pays the various kinds of taxes e.g. income tax. The main aim of incidence is to ensure that the burden of taxation is equally distributed among those who are able to pay tax. This is in accordance with Adam Smith’s canon of equality.

The determination of incidence is done by the following markers:

Elasticity: For this matter elasticity of demand and elasticity of supply must be taken into account. Supposing that demand for a taxed commodity is elastic, the tax is thus borne by the producer himself. However, if the demand for it is inelastic, the ultimate consumer bears the burden of tax. Similarly if the supply is elastic the tax burden is borne by the consumer and if it is inelastic the produce himself bears the tax burden.

Price: Price is an important determinant of incidence. Shifting of tax burden only takes place when it results in a change in price. If price remains constant, tax does not shift and hence no actual tax is charged.

Time: Generally the adjustments in production technology and know-how cannot take place in the short run. Hence, demand for the good depends largely on the rise and fall in price. Thus as a result of a decline in price, the producer himself has got to bear the incidence of the tax. However, in the long-period, full adjustments are possible and the incidence of tax is shifted on the consumer.

Cost: Changing the scale of production adversely affects the cost and this depends on whether the industry is an increasing, deceasing or constant cost industry. In this case of a diminishing cost industry, if the scale of production were to be reduced, this would raise the cost and also the price of the commodity. Incidence of taxation is borne by the consumer.

Nature of Tax: Windfall gains and losses will not shift the incidence of tax if there were to be any tax on windfall gains and losses.

Market Form: Under perfect competition no single producer or purchaser is able to influence the price level. Thus, there will not be any shifting of tax. However, in a monopoly market the monopolist can influence the price and shift the tax on the consumer.

There are various Kinds of incidence of taxes. First is the incidence of tax on monopoly. A monopolist is said to have already determined a price which will yield him maximum profit. Supposing a tax is levied on the monopolist’s profits, he will not be able to shift the tax anymore assuming that if he intends to do so by increasing the price level, this will in demand for this good and his profits will suffer.

Second is the incidence of tax on personal income. Generally economists are of the similar opinion that income tax cannot be shifted and is levied upon the person who bears it. However, to a certain extent businessmen can shift their income tax burden to the consumer in the form of higher prices. However, once again, they may only partially do this as a sharp increase in the prices will leave an adverse effect on their profits as they too face tough competition.

Third is the incidence of tax on commodities. There are various factors determining the incidence of tax on commodities.

Elasticity of Demand and Supply: As I mentioned earlier, if the demand for a commodity is inelastic, incidence of tax will be on the consumers. However, if demand is elastic, less is purchased and part of the tax is thus borne by the seller. When the supply of a commodity is elastic, incidence of tax falls on the consumer. This is because the producer is able to influence the supply of the goods, if the supply is inelastic; the producer bears the burden of tax e.g. perishable commodities because he is not in a position to raise the price by reducing the supply. Thus, the amount of tax levied on both parties depends upon the degree of elasticity of demand of supply.

If there are substitutes of a taxed commodity the seller cannot simply increase price level for fear of losing customers. Thus, in such a case the seller bears part of the tax burden. However, if the substitutes are imperfect, then the seller may be able to shift the whole tax burden on the consumer.

If a commodity is produced under law of diminishing returns, prices cannot be increased to the amount of the tax the cost of production is high and in doing so would result in losing customers. However, if the commodity is produced under law of increasing returns then prices may be increased even more than the actual tax as cost of production is low and buyers are not exactly adversely affected on the other hand. If the commodity is produced under the law of constant returns then the increase in price will be up to the exact amount of tax on the good.