Can a Tax Be Shifted Backward?

Check out this post if you are unfamiliar with tax shifting. It will help in understanding the following.

I was reading a section about tax shifting in Rothbard’s Power and Market last week when I was going over the same section for Liberty Classroom‘s Austrian Economics class.

Rothbard states “Shifting occurs if the immediate taxpayer is able to raise his selling price to cover the tax, thus “shifting” the tax to the buyer, or if he is able to lower the buying price of something he buys, thus “shifting” the tax to some other seller.” (p. 1156)

As he goes on to point out in the case of the general sales tax, however, both a producer’s selling prices go up and buying prices go down. So I thought these clearly could not be the key criteria.

He states “It is true that a tax can be shifted forward, in a sense, if the tax causes the supply of the good to decrease, and therefore the price to rise on the market. This can hardly be called shifting per se, however, for shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be “shifted,” it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation.” (p. 1156-1157)

My issue with Rothbard was, however, that I felt this argument could be flipped on him; Rothbard believed that a sales tax could be shifted backward.

I could say “It is true that a tax can be shifted backward, in a sense, if the tax causes the demand for the factors of the production of the good to decrease, and therefore the price of the factors to fall on the market. Production in this way is hampered, causing supply to decrease and marginal firms to go out of business. This can hardly be called shifting per se, however, for shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be “shifted,” it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation.”

This is because, even in Rothbard’s proposed correct version of events where a tax is shifted backward, supply decreases, meaning marginal firms go out of business.

If the above seems a little confusing to you, try this one instead:

In Murphy’s Study Guide to Man, Economy, and State with Power and Market, he states:

“Tax incidence refers to the actual long-run burden of taxation, which may differ from the immediate target. No tax can be shifted forward. (If retailers had this power, why wait for the tax?)”

I could reply “No tax can be shifted backward. (If retailers had this power, why wait for the tax?)”

That’s basically what I was trying to do, although my response to Rothbard’s is more detailed.

After discussing this with Dr. Herbener, he pointed out that the two cases are not symmetric in the relevant sense. What matters is not whether firms eventually go out of business, but whether firms immediately go out of business as a result of shifting the tax. It’s true that firms eventually go out of business in both scenarios, but in the forward shifting scenario, firms go out of business immediately (as supply decreases – this is the proposed mechanism for tax shifting for this scenario, firms immediately go out of business) while in the backward shifting scenario, firms go out of business eventually (the tax shift occurs earlier, the proposed mechanism being firms paying lower incomes to their facts, which they do not directly go out of business from, but eventually go out of business from because of the “other effects”).

Why is this important? Because the immediate effect is what matters for whether we call it tax shifting or not. If firms go out of business as an immediate effect of shifting the tax, this cannot be properly seen as shifting a tax. However, in every scenario where taxes are added to a free market, there will be “other effects”, or as I have been saying, eventual effects, where people are harmed, including firms. So firms being eventually hurt does not invalidate backward shifting as an example of tax shifting.

In conclusion, yes: a tax can be shifted backward and this is perfectly consistent with Rothbard’s argument against forward shifting.

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