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Home -> Merlin Harold Hunter -> Outlines of public finance -> Chapter 7

Outlines of public finance - Chapter 7

1. Preface

2. Chapter 1

3. Chapter 1 continue

4. Chapter 2

5. Chapter 2 continue

6. Chapter 3

7. Chapter 3 continue

8. Chapter 3 continue

9. Chapter 4

10. Chapter 4 continue

11. Chapter 4 continue

12. Chapter 5

13. Chapter 5 continue

14. Chapter 5 continue

15. Chapter 6

16. Chapter 6 continue

17. Chapter 7

18. Chapter 7 continue

19. Chapter 7

20. Chapter 7 continue

21. Chapter 9

22. Chapter 9 continue

23. Chapter 10

24. Chapter 10 continue

25. Chapter 10 continue

26. Chapter 11

27. Chapter 11 continue

28. Chapter 11 continue

29. Chapter 12

30. Chapter 12 continue

31. Chapter 13

32. Chapter 13 continue

33. Chapter 13 continue

34. Chapter 14

35. Chapter 14 continue

36. Chapter 14 continue

37. Chapter 15

38. Chapter 15 continue

39. Chapter 15 continue

40. Chapter 16

41. Chapter 16 continue

42. Chapter 17

43. Chapter 17 continue

44. Chapter 17 continue

45. Chapter 18

46. Chapter 18 continue

47. Chapter 18 continue

48. Chapter 19

49. Chapter 19 continue

50. Chapter 19 continue

51. Chapter 19 continue

52. Chapter 20

53. Chapter 20 continue

54. Chapter 20 continue

55. Chapter 20 continue



92. The Justice of a Tax May Depend on Its Shifting
and Incidence. A proper understanding of the terms
shifting and incidence is necessary before their discussion
can profitably be undertaken. Fiscal authorities may
place a tax upon a particular individual, which he will
pay. He may, however, in some way, transfer the bur-
den of this tax to a second individual; the second may
transfer it to a third, and so on. The burden must, how-
ever, finally rest somewhere that is, a point will be
reached where there will be opportunity or possibility for
no more transfers. This process of transferring a tax
burden from one individual to another is called shifting]
the point where the burden finally rests is called the inci-
dence. The expressions have the same meaning as when
applied by physicists to rays of light. A ray of light may
be shifted or refracted in various directions by mirrors or
prisms, but it will finally rest or hit upon some point, and
this point is its incidence. The incidence of a tax is
usually considered as the result of its having been shifted.
If, however, a tax burden remained where it was first
placed, the incidence properly might be said to be here,
even though no process of shifting occurred.

The shifting of a tax must be clearly distinguished from
the evasion of a tax. When an individual evades a tax
he neither pays it and bears the burden, nor does anyone
else. If all taxes were evaded no revenue would accrue
to the state, while if all were shifted the revenue would not
be affected, yet the person making the payment would


not feel the burden. When the holder of a mortgage, for
example, does not list it with the tax assessor, he evades
the tax. If, however, he lists the mortgage as a part of
his property, pays the tax levied upon it, and then charges
the mortgagor a sufficiently high rate of interest to recoup
himself for the tax, it is shifted, and the incidence is on
the mortgagor.

Justice in taxation has long been an important fiscal
problem, and from the time authorities began to give it
their attention the question of shifting and incidence has
received careful consideration. Some of the early theories
of taxes find their justification in the ideas which were
held concerning this particular phase. The ideas were
sometimes unsound, and the tax systems were modified
as experience showed the fallacies around which they
were built. Some attention has been given to the shifting
and incidence of revenues from the beginning of fiscal
operations, yet it is only recently that any scientific study
has been made as to causes, results, and methods. It is
at present one of the most important questions if, in-
deed, not the most important to be considered in deter-
mining the justice of taxes. It is only when knowledge is
had of the real bearer of a tax burden, that correct judg-
ment can be passed as to the real justice of that tax.

To know merely that a tax has been shifted is often
insufficient knowledge to a reader or an investigator. It
is not known how far the incidence is removed from the
levy of the tax, whether the tax has been shifted once,
twice, or a half dozen times. Neither is it known whether
the shifting has been backward toward the producer, or
forward toward the consumer, yet a tax might be shifted
in either direction, depending on circumstances which
will be discussed later. Where there has been more than
one stage in the shifting process, a student often wants to
notice the consequences of the tax, or the mode of shifting
at one or more of these stages. The expressions, original
incidence, or first incidence, second incidence, and so on ?


are sometimes used to denote the different stages in the
shifting process. When used without a qualifying word,
however, incidence refers to the final resting place of
a tax.

A fiscal system which attempted to levy taxes only
upon the individuals most able to bear tax burdens, might
be very unjust in its operation because of the shifting of
these burdens. The attempt should be made to levy
taxes so that the incidence will occur where there is the
greatest ability to bear the burden. Such an ideal, of
course, would be difficult to attain, but it can be more
nearly attained if fiscal authorities understand and apply
the principles that govern the shifting and incidence of

93. A Study of Shifting and Incidence Is Fundamen-
tally a Study of Price. 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 possi-
ble. 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 fal-
lacy of such reasoning.

Suppose an individual buys a s.uit 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 bur-
den. 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 in-
crease 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 distinc-
tion, 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 interest-
ing to note the possibility of shifting some of the more
common taxes.

94. General Poll and Income Taxes Cannot Be Shifted.
The conditions just considered, which make the shifting
of taxes possible, are scarcely applicable to some taxes,
while they are easily applied in the case of others. Gen-
eral poll and income taxes furnish good examples of those
which cannot be shifted, because of the applicability of
the laws of price.

General Poll Tax. Poll and income taxes are more
closely connected with personality than are any other
forms of taxation. There is no possibility of a general
poll tax changing the price of something used by some
one else, so as to make him bear the burden. The burden
of a general poll tax of $10 upon every person over twenty-
one years old would fall on the individuals of that class.
It may be necessary to expend more energy in order to
get funds to meet the tax, or the tax may be evaded, as
is the case of many of the poll taxes in the Southern states,
but this does not shift the burden.

It is conceivable, however, that a general poll tax could
be made so burdensome as to postpone the age of marriage
and materially reduce the size of families. The long-time
effect, therefore, might be to lessen the supply of labor
relative to the demand, and cause a shifting of the tax to
the extent that a decrease in numbers, due to the tax,
caused a higher wage. In this case a greater burden
would be placed upon employers because of the tax.

Local Poll Tax. The immediate effect of a poll tax
levied by a particular community differs materially from
a general poll tax in its possibility of being shifted. Sup-
pose one county in western Pennsylvania would levy an


annual poll tax of $100 upon every male person over
twenty-one years old, while the adjoining counties had no
such tax. Laborers would leave the county with the tax
to seek employment where the tax system was less bur-
densome. This decrease in labor would mean an increase
in wage to those who remained. The tax will have been
shifted to the employer to the extent of the wage increase.

Income Taxes. The possibility of shifting income taxes
follows practically the same reasoning as for poll taxes.
A general, proportional income tax would hardly be
shifted. An individual would not cease to get an income
because it were taxed, neither would he gain by going to
another locality or occupation where the tax conditions
were the same. If the tax were large enough to be burden-
some it might, over a period of tune, have the same effect
as a burdensome poll tax in reducing numbers. This re-
duction in the size of the family in order to maintain a
certain standard of living, will result in higher wages than
would otherwise exist. The price of labor has gone up
because of a tax, and the tax has been shifted to the ex-
tent of the wage increase.

Where rates vary for different communities there is
likely to be a readjustment of the labor supply, with a
shifting of the tax to the extent of increased wages due
to the readjustment. Shifting might also take place if
incomes from one occupation were taxed more heavily
than incomes from another. Suppose that, under the
police power, the income of teachers should be made ex-
empt from taxes while no exemption were made for book-
keepers and stenographers. This would make teaching
more desirable and the other occupations less desirable.
The number of bookkeepers and stenographers would
decrease, with a corresponding higher wage to those re-
maining. In so far as this would be true, the tax would be
shifted to the extent of the increased wage. These cases
are mere possibilities, and as a general proposition neither
general poll nor income taxes can be shifted.


95. Land Taxes Are Often Called Burdenless Taxes.

It is a generally accepted principle that a tax on land
values is capitalized, and that sufficient allowance is made
in the purchase price that the burden of the tax continues
to remain on the individual who owned the land when the
tax was levied. An example will make clear how this
principle is supposed to work. A man contemplates buy-
ing a farm, and calculates that the net income from its
operation would be about $2,200, which, capitalized at the
current rate of return on similar investments, say 5 per
cent, would make the value of the farm $44,000. In these
figures, however, he has neglected to take into account
the annual tax of $200. When this is considered the
annual net income is reduced to $2,000, which, capitalized,
will give a valuation of $40,000 that the purchaser will be
willing to pay. He keeps the additional $4,000 that he
would have been willing to pay for the farm had there
been no tax, to endow permanently the annual tax of
$200. The seller, by being compelled to accept $40,000
instead of $44,000, has borne the burden of the $200 tax
as long as it exists.

It is possible that the supposed purchaser of land may
want to sell his purchase. He does not feel the effect of
the tax as did the original seller. The income, less the
tax, will still be the same, and the selling price will be the
same as the purchase price so far as the tax is concerned.
The tax has been paid year after year, yet the owner of
the land has felt no burden of it. It is often asserted,
therefore, that the burden of a tax remains upon the
owner of the land at the time of the levy, and is burden-
less upon all future purchasers. In other words, a tax on
land values cannot be shifted to the purchaser.

Tax on Land Values. It is generally believed that an
increase in taxes on land values is often shifted by the
landlord to the tenant through collecting a higher rent.
A correct understanding of the nature of rents will reveal
the fallacy of such thinking. Students of economics are


familiar with the differential nature of rents. They repre-
sent a surplus which belongs to the owners of the better
grades of land. Rent represents the difference between
the return from these better grades of land and the return
from that grade of land which it just pays to cultivate at
the prevailing prices for the products from the land.
This marginal grade of land has no rental, hence no capi-
tal value to be affected by a tax. Before a tax would
lessen the amount of land under cultivation it would have
to be 100 per cent of this rental surplus. A tax upon
values, then, would have no effect upon the amount of
land used for cultivation. The tax, on the other hand, in
no way affects the demand for the products from the land,
hence prices and the differential advantage, in rent, will
remain the same as without a tax. Land is no more or
less desirable to a tenant after a tax levy than before.

It may appear, sometimes, that the landlord shifts the
tax in a higher rent charge. If, for some reason, the ten-
ant has not been paying the full differential surplus, then
it may be possible for the landlord to raise the rent and
think he is shifting the tax. What he does, however, is to
get more or all of the surplus which he should have been
getting before because of the differential advantage of
his land. The landlord, then, must bear the new tax,
which makes the land a less desirable investment than it
was before the tax was levied. Demand will fall off for
this class of property, with a consequent fall in the price
of land values. Again it is seen that the burden of such
a tax once and for all falls upon the owner of the land at
the time of the levy.

Specific Tax on Land. A specific tax on land would
have very different results. Here the demand and supply
relationship would be changed, which would result in price
changes through which the shifting of the tax could be
accomplished. Suppose a new tax of $10 an acre to be
placed on agricultural lands. The poorest land under
cultivation, however, has just been remunerating capital


and labor for the energy expended in production. Again
the imposition of the tax makes the products no more
desirable, and capital and labor cannot afford to con-
tinue to use this land, but will seek other fields where
it will be properly remunerated. This action causes a
decrease in the amount of products put on the market,
with a corresponding rise in price. Through this price
change the owners of lands which will continue to be
cultivated will partially recoup themselves for the $10
an acre tax.

Tax on Nonreprodudble Goods. General taxes on non-
reproducible goods have the same characteristics as taxes
on land. They are capitalized by a prospective buyer
and the purchase price is so modified that the burden
rests on the owner at the time the tax was levied. A tax
upon bonds previously exempt would be offset by a de-
creased selling price. Suppose, for example, there were
no taxes on 5 per cent bonds, and that under this condi-
tion the bonds were selling at par. The government now
places a tax of 1 per cent on this class of bonds, which
reduces the return to 4 per cent. A purchaser will con-
sider only such a figure as will bring him 5 per cent on his
investment that is, he will be willing to pay no more
than 80 for perpetual bonds. The seller must take a 20
per cent discount because of the tax. A tax on such non-
reproducible goods as pictures, curios, etc., would have
the same effect. The levy of a tax does not increase the
desire for the goods, the purchase price will be decreased,
and the burden remain on the seller. If the tax were a
local one, however, rather than general, it might be evaded
by moving the goods. Herein lies one important differ-
ence between such goods and land.

From these apparent results of a tax on land and other
nonreproducible goods, it appears from the standpoint of
justice that such taxes should be permanent rather than
temporary. Not all property changes hands within a
given period. A temporary tax would be unjust to those


transfers which were made while the tax existed, because
the burden of future taxes would be saddled upon the
transferor, while in a preceding or succeeding period of no
tax the burden would be entirely different. The same
principle applies to the taxation of inheritances. An in-
heritance tax should be permanent so the burden on in-
heritances made at different times will not be different.

96. Taxes on Buildings May Be Shifted. Since the sup-
ply of buildings is not constant, but may be materially
changed over a period of time, a tax placed upon them is
somewhat different, as regards shifting, from a tax placed
upon land. Because of the relative fixity of capital in-
vested in buildings, however, the total or partial shifting
of the tax may take place only after a period of time. It
may be assumed that the competition of the different
forms of investment for capital will have worked itself
out so that capital invested in buildings will be receiving
the normal return. Suppose that the government now
levies a tax upon buildings which will diminish this re-
turn, and that the owner attempts to reimburse himself
by exacting a higher rental from the tenant. The rent
item in the budget of the tenant is already as large as he
can afford, and rather than meet an increase he will move
to a less desirable building. Other tenants will do the same
until some previously submarginal buildings may be
brought into use. Here, as in the case of land, the product
is no more valuable to the consumer because it is taxed,
the tenant is unwilling to pay more than the utility repre-
sented, and the landlord must bear the burden.

Over a period of time the situation is likely to change.
The pressure of the tax makes the investment of capital
in buildings less profitable than before the tax was laid,
and less profitable than other forms of investment which
were excluded from the tax. Capital will cease to flow
into this field and the supply of buildings will remain
stationary. As population increases, however, the demand
for buildings increases, with a corresponding rise in


rentals. They will continue to rise until capital invested
in buildings again will be getting the current return,
when more buildings will be produced. Rentals have
raised because the tax caused the supply of buildings to
remain stationary, while there was a continuous increase
in demand. Over a period of time, then, because of in-
creased rentals due to a readjustment of the supply and
demand, the tenant will bear the burden of a tax on

In purchasing a building the same considerations apply
as in the purchase of land or bonds. If the payment of a
tax is going to cause the receipt of less than the current
rate on the investment, the tax, or a part of it, will be
capitalized and deducted from the purchase price. To
the extent that this is done the burden falls upon the

97. The Capitalization Theory Has Been Ably Criti-
cized. 1 The theory that taxes on land and other non-
reproducible goods continue to remain a burden upon the
owner of the property at the time of the tax levy, has not
gone unchallenged. A brief consideration of some of the
criticisms may be well worth while. They have been sug-
gested, in fact, in the above treatment of the capitaliza-
tion principle.

An individual who wishes to invest capital has a num-
ber of possibilities industry, buildings, land, bonds, as
well as other fields. Assuming similar degrees of risk,
the important factor which will govern the decision is the
rate of return. He must, however, compare the rate of
return to be received from the taxed land with that from
other industries, also taxed. If all other forms of invest-
ment of the same degree of risk as land were so taxed that
1 per cent of the net income be taken, which would leave
a realizable return of 5 per cent, then the purchaser of

1 For an able criticism of this principle, see an article by T. S. Adams in
the American Economic Review for June, 1916. E, R. A. Seligman has a
reply in the Peeember issue of the same year.


land will be satisfied with a 5 per cent return from his
land. But in accepting this return he unconsciously bears
the tax burden placed upon the investments with which
he made comparisons.

If the landowner were bearing no tax burden, his rate
of return would be greater than that received from taxed
industries. What the purchaser of land would capitalize
and refuse to include as a part of the purchase price would
be any excess in land taxes over the taxes on other forms
of investment. He expects the current rate of return, and
will not be willing voluntarily to shoulder a tax burden
which would cause his return to be less than this. Invest-
ments in land, after all, possess no special privileges or
immunities. It may seem that the purchaser is only
tacitly paying a tax whose burden has already been
shouldered. In reality, however, he is silently bear-
ing the tax burden in that he has accepted, as a return
on his investment, the current return from other taxed

Correction of Injustice. If a tax on land and similar
investments becomes burdenless, then a rank injustice is
being perpetrated by allowing such a condition to con-
tinue to exist. A particular class is escaping tax burdens
which other classes are called upon to bear. The just
solution for such an evil would be, not only to have this
class pay the tax which is no burden, but to place an addi-
tional tax upon it equal to the burdens felt by other
classes. That is, immediately after the sale of a piece of
land, bonds, or other similar forms of property, there
should be a new or additional tax placed on them. But
in order to do this the purchaser would somehow have to
be led to believe that it was not going to be done other-
wise he will capitalize the contemplated tax, not only the
immediate one, but all future ones, and the logical outcome
would be the destruction of values.

Illustration of Bond Sales. An illustration will make
clear the effect of an attempt to make use of such a scheme


as that just outlined. Suppose a purchaser contemplates
buying bonds on which the annual tax is 1 per cent. Under
the capitalization scheme he will escape this burden by
paying less for the bonds than he otherwise would have
paid. To somewhat equalize tax burdens, then, suppose
an additional 1 per cent tax be added. On a resale
this would also be capitalized, and the purchase price
accordingly reduced, necessitating another increase in
the tax rate to equalize burdens. After a few such
sales the income from the bonds would be entirely taken
in taxes.

If the original purchaser knew this was to be the future
policy in levying taxes, allowance would be made for the
capitalization of all these new taxes after resales, and the
price he would be willing to pay would be materially les-
sened. It could be only through some form of deception
through levying some form of tax that the purchaser
did not expect that he could be made to bear the so-
called burden. The situation w r ould be more literally true
with land than with bonds. The latter might be pur-
chased with the idea of holding to maturity, while the
only way of securing capital invested in land is by

Conclusion as to Burdenless Taxes. Such reasoning, no
doubt, seriously questions the commonly accepted "bur-
denless taxes" which are supposed to arise from the pur-
chaser deducting the capitalized tax from his otherwise
purchase price. The important thing to be considered in
making an investment, aside from risk, is the rate of re-
turn. A tax is one of the factors which will affect this.
When the current rate of interest is 5 per cent, 5 per cent
bonds will sell at par. They are, however, silently bearing
the tax placed upon other investments, because it is the
return from these investments with which the bondholder
is satisfied. If, somehow, all taxes should be removed
from these other investments, the returns from them
would immediately go to 6 or 7 per cent. The immediate


effect of this on the bond values would be to force them
below par, till the same return were realized.

By using the current rate of return, then, as the basis
for his calculations, an investor bears the ordinary rate
of taxes in purchasing land and similar kinds of property.
If, however, the property to be purchased bore taxes in
excess of the ordinary rate, which would result in a less
than normal net return, this excess would be capitalized
and deducted, in order that the return be the same as for
similar forms of investment.

98. All Taxes on Monopolies Will Not Be Shifted to the
Consumer. The opinion is prevalent among the unin-
formed that a monopolist has absolute control in fixing
price that he can fix it at any place he chooses. A tax
placed upon a monopoly or upon a monopoly-produced
good, then, is believed to be shifted over to the consumer
by the monopolist simply adding the amount of the tax to
the price of the product.

A monopolist, however, possesses no such broad powers.
In some cases a tax may be shifted, or partially shifted,
while in other cases no attempt would be made to shift
the tax burden. When shifting is accomplished, even by
a monopoly, the same laws of price must be observed
as hi any other case of shifting. A monopolist can
have very little, if any, direct control over demand. A
good produced by a monopoly possesses no more utility
than if it were produced under competitive conditions,
and it will bring no higher price. The power of the
monopolist lies in his ability to control the amount
of goods which will be placed on the market, and this
supply in conjunction with the existing demand will
determine the price. The attempt will ordinarily be
made to regulate the supply so as to receive the highest
net returns.

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