Fiscal incidence

Fiscal incidence is a concept within public finance, a sub-discipline within economics, that refers to the combined overall economic impact of both government taxation and expenditures on the real economic income of individuals.

While taxation reduces the economic well-being of individuals, government expenditures raise their economic well-being. Fiscal incidence is the term for the overall impact of government taxing and spending considered together.

In theory, governments withdraw resources from society in the form of taxation, and contribute resources back into society in the form of expenditures. However, the burdens of taxation are not borne equally by individuals, and the benefits of government expenditures are not distributed equally throughout society. As a result, the distribution of tax burdens and government expenditure benefits is an important economic question to those concerned with the equity of the fiscal system. When the economic incidence of taxation is combined with the economic incidence of government expenditures, the result is a measure of the overall increase or decrease in welfare that individuals enjoy from the state's taxing and spending policies. This is referred to as fiscal incidence.

Early empirical studies of fiscal incidence date to the 1940s. Two early studies included Charles Stauffacher's (1941) study of the United States from 1930–39, and Tibor Barna's (1945) study of the United Kingdom for 1937. Both studies identified substantial income redistribution with Stauffacher concluding that the lowest income group received 27 percent of federal spending between 1930-39 while paying 5 percent of federal taxes. Barna's conceptual framework—first developed as a doctoral candidate at the London School of Economics under Nicholas Kaldor—was influential and today serves as the essential framework for fiscal incidence studies conducted by the British government.

Early results for the United States demonstrated that overall tax policy was mildly progressive — that is, when regressive state-local tax systems are combined with progressive federal taxes, the result is mildly progressive overall. On the spending side, early results illustrated that the distribution of expenditure benefits as a percentage of income was progressive as well, making the overall fiscal system more progressive that is apparent from the tax system alone. As a result, early studies found that overall fiscal incidence resulted in a net redistribution of income between income groups within the United States, from higher-income individuals to lower-income individuals. Here the term "progressive" refers to benefits accruing to lower-income individuals as opposed to those with higher incomes; "regressive" conversely refers to benefits accruing to higher-income individuals as opposed to those with lower incomes. The neutrality of these terms has been debated, but they are widely used in economic literature.

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