tax incidence
When a government taxes a product, there's a question that sounds simple but isn't: who actually ends up paying it? You might think it's whoever the law hands the bill to — the shop that mails the cheque to the tax office. But economics has a striking answer: the legal payer and the real payer are often different people. Tax incidence is the study of who truly bears the burden of a tax, once the price has adjusted, regardless of who is legally required to hand it over.
Here's the mechanism. Put a 1-dollar tax on each coffee, collected from sellers. Sellers try to pass it on by raising the price, but they can't always pass on the full dollar, because a higher price drives some buyers away. So the price typically rises by less than a dollar — say 60 cents — and that 60 cents is borne by buyers, while the seller eats the remaining 40 cents out of their own pocket. The tax has been split, and crucially the split is identical whether the law collects the tax from sellers or from buyers. The legal side of the market is irrelevant to who really pays — a genuinely counter-intuitive result.
What does decide the split is relative elasticity: the more inelastic side of the market bears the bigger share. The intuition is that whoever can least easily walk away gets stuck with the bill. Buyers of an addictive, substitute-free good (cigarettes) can't easily cut back, so they shoulder most of a tobacco tax even though shops technically remit it. Where supply is the rigid side — beachfront land, say — sellers bear more. This is the heart of how economists analyse any sales tax, excise duty, or tariff: the question is never just "who pays on paper" but "who can least afford to flee the price," with the side-effect that a tax shrinks the quantity traded and creates some deadweight loss.
A tax on cigarettes is collected from shops, but smokers' demand is so inelastic that nearly the whole tax shows up in a higher shelf price — so smokers, not shops, bear most of the burden, exactly as the relative-elasticity rule predicts.
The inelastic side — the one that can't walk away — pays the larger share, whoever the law bills.
The biggest surprise here: it makes no difference whether a tax is legally levied on buyers or sellers — the real burden splits the same way, set entirely by relative elasticity. "They'll just pass it on to consumers" is sometimes true and sometimes not; it depends on the elasticities.