Friday, November 04, 2005

Who pays for the EVAT?

Our lesson for today: Tax incidence. Exhibit A:

On the first day of EVAT GMA gave to me…Deep into Halloween night, I was snug at hearth and home, safe from the witches and all sorts of icky creatures from the dark celebrating their mardis gras, when it occurred to me that the real horror of Halloween ’05—EVAT—would be upon the populace at midnight.

I rushed to the nearest open gas station and found myself at the end of a snaking line of vehicles. You’ve ever been in line for a dozen “Amazing Glaze” at the original “GoNuts Donuts” store at the Fort? That approximates the line at the service station I went to, only longer because the queues were processions of cars, not of people.

How kind of the gas station management to open on All Souls Day to sell gas at pre-EVAT prices when it very well could have closed for the day, as most service stations did, to give their employees a chance to observe Undas, in the process conserving pre-EVAT fuel stock to be sold at E-VAT prices.

Zeroing in on the last para: it's not out of kindness that the gas stations were accommodating the gas demand at undas. It was motivated by profit maximization. Both sellers and buyers pay the EVAT; that is, profits gets squeezed too by the tax. So better sell more liters during the time that profit per liter is greater.

But isn't EVAT charged to consumers? Sure, on paper. But in the marketplace, that would only happen if the price rises by the same amount as the added tax. That's not going to happen. In fact, as the prices have been holding steady the last few days (though the EVAT is already in effect for all transactions from Nov. 1), it's clearly not happening now.

The economists' explanation for this relies on three factors (see, economics is good for something after all.) First is the fact that the price equals the cost of the last unit sold (the jargon is "marginal cost"), plus tax. Second is the fact that as price increases, consumers cut back on their spending. Third is the fact that in general, the more output is produced, the most costly is the last unit produced. So put it all together: suppose price goes up by the amount of the tax. Consumers buy less. Producers sell less. Their last-unit cost goes down. So the price plus tax goes down (relative to the original price plus tax.)

So clearly the adjustment of price, and the incidence of the tax, depends on: the rate at which last-unit cost varies with respect to output; and the rate at which buyers cut back on purchases as price increases. Once we know these, we can predict how much the market price goes up, and who pays what share of the tax. That requires a sector-by-sector analysis. No need to bore you with the details. Now you know the basic principles determining who pays for the EVAT. Or at least, you know that kindness is not one of these principles.

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