THE MODERN THEORY OF TAXATION

INTRODUCTION:-

Modern theory of taxation is one of the important contributions of Dalton to economics. This theory is also known as the Modern theory of shifting and incidence. In this theory Dalton shows the relationship between the burden of taxation with elasticity of demand and supply.

ASSUMPTION

This theory is based on the assumption of "ceteris- paribus" means other things being unchanged.

THE THEORY

According to this theory

1. There is direct relationship between the elasticity of demand of the taxed good and the burden borne by the seller.

2. There is negative relationship between the elasticity of demand of the taxed good and the burden borne by the buyer.

3. There is positive relationship between supply elasticity of the taxed good and the burden borne by buyer.

DIAGRAMATICAL EXPLANATION

Elasticity of demand and supply of the taxed good has effect on the tax burden of both the seller and the buyer. It can be explained with the help of the following diagram.

 

In the above diagram, DD is demand and SS is supply curve. At the point E, the demand and the supply of the commodity is equal and thus this point represents the market equilibrium of the commodity. Hence, the equilibrium price is OP and equilibrium quantity is OQ.

Now, because of the imposition of tax at E1R, the supply curve shifts to S1S. The price also shifts to OP1. Therefore, the burden borne by buyer is E1T and the rest TR is borne by seller.

Symbolically,

                   Ed = ∆Qd/ ∆p * P/Q

                        = QQ1/PP1 * OP/OQ

                        = QQ1/E1T * QE/PE

Es  =  ∆QS/ ∆P × P/Q

= QQ1/PP1 × OP/OQ

= QQ1/TR × QE/PE

NOW,

      Ed/Es = QQ1/E1T × QE/PE × TR/QQ1 × PE/QE = TR/E1T //

             Therefore, Burden of seller (related to Ed) = TR

              Burden of buyer (related to Es) = E1T

PROPOSITIONS OF THE THEORY

1.       If elasticity of demand and supply of the taxed good is equal, then the burden of tax is also equal on both the seller and buyer.

2.       In case of elasticity of supply> elasticity of demand, the burden falls on buyer>burden falls on seller.

In the following diagram, burden of tax is ER

Burden borne by seller= TR

Burden borne by buyer= E1T

E1T> TR

3.       If elasticity of demand> elasticity of supply, the burden borne by seller> burden borne by buyer.

4.       If demand is perfectly elastic, the whole burden of tax is borne by the seller.

In the following diagram, we see that the price is unchanged. Therefore buyers don’t bear any burden. The whole burden has to be borne by the seller.

5.       If demand if perfectly inelastic and supply is elastic, then the whole burden of tax is borne by the buyer.

In the diagram, DD is the inelastic demand curve. We see that demand of a commodity remains the same. So price of the commodity rises. Therefore the whole burden of tax has to be borne by the buyer.

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