Elasticity and the incidence of tax
tax burden 
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If the actual incidence of a tax is independent of its statutory assignment, what does determine the incidence? The answer: The incidence of a tax depends on the responsiveness of buyers and of sellers to a change in price. When buyers respond to even a small in- crease in price by leaving the market and buying other things, they will not be willing to accept a price that is much higher than it was prior to the tax. Similarly, if sellers respond to a small reduction in what they receive by shifting to the production of other goods or going out of business, they will not be willing to accept a much smaller payment. net of tax. The burden of a tax- its incidence- tends to fall more heavily on whichever side of the market has the least attractive options elsewhere- the side of the market that is less sensitive to price changes, in other words.
In the preceding series of posts, we saw that the steepness of the supply and demand curves reflects how responsive producers and consumers are to a price change. Relatively inelastic demand or supply curves are steeper (more vertical), indicating less responsiveness to a change in price. Relatively elastic demand or supply curves are flatter (more horizontal), indicating a higher degree of responsiveness to a change in price.
It will not be easy for gasoline consumers to shift- particularly in the short run- to other fuels in response to an increase in the price of gasoline. The inelastic demand curve shows this. When a 20-cent tax is imposed on gasoline, buyers end up paying 15 cents more per gallon ($2.05 instead of $1.90), while the net price of sellers is 5 cents less ($1.85 instead of $1.90). When demand is relatively inelastic, or supply is relatively elastic, buyers will bear the larger share of the tax burden.
Conversely, when demand is relatively elastic and supply is inelastic, more of the tax burden will fall on sellers and resource suppliers. The luxury-boat tax illustrates this point. As we mentioned earlier, Congress imposed a tax on the sale of luxury boats in 1990. Later, the tax was repealed because of its adverse impact on sales and employment in the industry. There are many things wealthy potential yacht owners can spend their money on other than luxury boats sold in the United States. For one thing, they can buy a yacht someplace else, perhaps in Mexico, England, or the Bahamas. Or they can spend more time on the golf course, travel to exotic places, or purchase a nicer car or more expensive home. Because there are attractive substitutes, the demand for domestically produced luxury boats is relatively elastic compared to supply. Therefore, when a $25,000 tax is imposed on luxury boats, prices rise by only $5,000 (from $100,000 to $105,000), but output falls substantially (from 10,000 to 5,000 boats). The net price received by sellers falls by $20,000 (from $100,000 to $80,000 per boat). When demand is relatively elastic, or supply is relatively inelastic, sellers (including resource suppliers) will bear the larger share of the tax burden.
The Liquidity Rally – practice
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The collapse of the Thai baht extended well beyond levels seen on the first day of “flotation”. Having been around THB25 to the US dollar before the “flotation” (devaluation), it subsequently fell to a low of 56.3 in the coming months, a decline in value of over 40%. In the case of the Indonesian rupiah, the fall was even more spectacular, plunging from IDR2,300 to the dollar to a low of 17,000, a devaluation of 85%! Asian countries generally tightened monetary policy in order to temper the threat of imported inflation from currency devaluations and in line with the IMF’s initial call for tightening of both fiscal and monetary policy. Policy tightening in the face of maxi-devaluation of the currency tends to cause a slowdown in the economy to become a recession (if not a depression!), and in the cases of Thailand and Indonesia that is indeed what happened. In 1998, the Thai economy contracted 9.5%, while that of Indonesia contracted 13.2%. Whatever the merits of these policies, which were ostensibly aimed at providing long-term economic stability, there is no question that in the short term they severely exacerbated the regional economic slowdown. At street level, millions were forced into poverty. The World Bank estimated that half of Indonesia was living in a state of absolute poverty in 1998, defined as earning less than USD1 a day. Unemployment levels skyrocketed. Retail prices rose sharply to offset the free-falling currency in the likes of Indonesia, the Philippines and Thailand. Interest rates were tightened to offset this, compounding the misery.
In the wake of this, several leading commentators were heavily critical of the IMF policy response to the Asian crisis, saying the combination of tight fiscal and monetary policy represented a worse cure than the disease itself. While I have some sympathy with this view, particularly as public policy adjustment is not necessarily the appropriate policy response to private sector imbalance (too many Asian companies borrowing too much in dollars and speculating too much in their own stock and property markets), this still does not answer the question of how one stops a currency from free-falling. This is a key consideration bearing in mind that the collapse of the rupiah resulted in the bankruptcy of almost every company in Indonesia. Whether you favoured the argument of the IMF’s Herbert Neiss or Harvard’s Jeffrey Sachs, it is pretty irrelevant. By then, the damage was already done; the battle had already been lost. By then, it was a question only of damage limitation.
The example of the Brazilian crisis, however, suggests some refinements to the standard IMF policy response have been considered — not least at the IMF — in the wake of the Asian crisis. When the Brazilian real devalued in January 1999 and subsequently fell to a low of 2.2200 to the dollar from its 1.20 band level, many forecast 2.50 or even 3.00 and a similar type of recession to that Asia had experienced. In reality, neither of those two possibilities happened. Clearly, the appointment of Arminio Fraga as the new head of the Brazilian central bank was an important stabilizing measure, as Fraga was a widely respected figure in the financial markets. The maintenance of trade finance for Brazil was also a crucial difference.
Whatever the differences, the similarities between the crises in Asia and Brazil — and also with Mexico, Russia and Turkey — are clear. Most notably within this was the fact that once inflation peaked so too did local interest rates, allowing for a substantial rally in asset markets and the currencies themselves. In Indonesia, for example, this meant interest rates coming down from around 75–80% and the dollar–rupiah exchange rate falling back from around 17,000 to around 6500. Equally, in Thailand, the dollar–Thai baht exchange rate fell back from 56 to around 35. In the case of Brazil, the dollar–Brazilian real exchange rate fell back from 2.22 to 1.63. Fundamentally, during this period, the trade accounts in many Asian countries swung from significant deficits to massive trade and current account surpluses.