Adam Rosenzweig (Washington University), How Pigouvian Taxes Work on Sellers, and Why We Should Care (JOTWELL) (reviewing Kyle Rozema (Northwestern), Supply Side Incidence of Consumption Taxes (2017)):
Empirical testing of the tax laws, and in particular testing the incidence of the tax laws, may sound boring. But virtually any modern public policy goal that could be implemented through tax policy ultimately turns precisely on this question. For example: Should the United States adopt a tax on sugary drinks? Is a high cigarette tax effective in preventing smoking deaths? Would a carbon tax help to reduce global warming? Ultimately, the answers to these questions turns on who, in fact, ends up bearing the burden of these taxes.
Such proposals often represent forms of so-called Pigouvian taxes. Proponents of Pigouvian taxes support them by contending that they can be used to reduce inefficient behavior by forcing consumers to internalize the full costs of such activities. Opponents of Pigouvian taxes often point to the regressive effect of such taxes on consumers, because they increase the cost of goods by a fixed amount of taxes, which disproportionately harms those consumers least able to afford such taxes. A fair amount of literature has arisen to resolve this question, primarily focusing on the empirical question of whether increasing the price of certain goods through higher taxes in fact reduces the amount of consumption and who bears the costs of such taxes. Virtually none of the literature in this area asks a related, but equally important, question: how do Pigouvian taxes impact different types of sellers of such goods?
Kyle Rozema provides one of the first attempts to address precisely this question in his article Supply Side Incidence of Consumption Taxes. More specifically, Rozema asks: How does a cigarette tax affect sellers of goods, as opposed to buyers of goods? The question matters because if the purpose of the cigarette tax was to serve as a Pigouvian tax, it would work only if it actually increased the price of cigarettes to consumers. Ultimately, however, the behavior of both buyers and sellers determines the equilibrium price of the goods. As an initial matter, this seems like an obvious question. After all, a Pigouvian tax works by charging more for a good which, in turn, should reduce demand (depending on the shape of the demand curve). But what if sellers don’t, in fact, raise prices in response to the tax? Even worse, what if some do and some don’t? As becomes readily apparent, taxes that are not fully passed on through retail prices would be less effective at reducing consumption, thereby undermining the purpose of a Pigouvian tax in the first place. ...
Rozema’s results are striking. Not only do they provide new insights in an area where many may have thought empirical analysis would be impractical, but they also potentially challenge many of the theoretical foundations underlying the use of Piguovian taxes. Rozema’s paper represents some of the best of what empirical tax research can and should do. It looks to an important area of tax and public policy, finds a significant gap in the micro-foundations for such policy, and uses a creative and novel data to begin to address that gap. Rozema attempts to shed light on the issue and clarify the trade-offs inherent in adopting Pigouvian taxes not only from a consumption side but also from a supply side.