The actual burden of a tax doesn't always fall on the person who pays the tax -- this concept is called tax incidence.

In economics, tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare. Tax incidence is said to "fall" upon the group that, at the end of the day, bears the burden of the tax. The key concept is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply.

More simply: the person who is required to pay the tax will try to shift the cost of the tax onto someone else. Easy example: your employer nominally pays 6.2% Social Security and 1.45% Medicare taxes on your behalf, but the tax incidence falls entirely on the employee -- your salary would be 7.65% higher without these taxes.

Tyler Cowen points out that the difficulty of tax incidence makes it hard to successfully tax high-earners no matter how you craft the tax structure.

Let's turn to taxation of the top 0.1 percent, and focus on these CEOs. If the tax rate on their income/K gains goes up, the firm will compensate by giving them more equity/options, to keep them working hard. In other words, the tax rate on the top earners can be hiked without much effect on CEO effort because there is an offset internal to the firm. At some margin the firm's shareholders will be reluctant to chop off more equity/options to the CEO, but the marginal value created by maintaining the incentive seems to be very high, for reasons presented above, and so the net CEO incentives will be maintained, even in light of new and higher taxes on CEO earnings.

But here's the problem, if that's the right word. The incidence of that tax is going to fall on shareholders in general and thus on capital in general. These top CEOs could even get off scot-free, if the shareholders up the equity/options participation of the CEO to offset completely the effects of the new and higher tax rate.

More simply: when you raise taxes on the wealthy, they just increase their income and pass the cost of the tax onto their shareholders, employees, etc. Taxes "trickle down" just like wealth does. Perhaps this is a partial explanation of why so many wealthy people seem to support the Left's high-tax agenda... they expect to avoid the effects of the taxes by passing the costs down the line.

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