Excise-Tax Shifting and Incidence: A Money-Flows Approach

Abstract

T HE money-flows analysis reported in this paper grew out of attempts to cope with one of most intractable obstacles in path of theory of excise-tax shifting and incidence, namely, problem of distinguishing between fiscal and monetary effects on market prices. The conventional expedient for coping with this obstacle is to try to avoid it by impounding monetary conditions in ceteris paribus while imposing an excise tax. Although this conventional expedient may be useful for certain analytical purposes, it is no real solution of problem. Price effects of impounded monetary conditions always return, like proverbial drowned cat, to plague excise-tax theorist. Even Harry Gunnison Brown, whose pioneering analysis of of a general output or sales tax is best of three significant articles examined in this paper, was not quite able in two attempts to distinguish between price effects of his tax and those of his assumed constant quantity of money in circulation.2 Direct assaults on this intractable monetary obstacle have recently been attempted by two writers. Earl R. Rolph located crux of this problem in question: If excise taxes raise prices to consumers, what shall be done about monetary theories which hold that an increase in aggregate demand is a necessary condition for a rise in general level of prices?3 His proposed solution was to convert quantity theory of money into a tool for excise-tax theory by means of his income effect. This paper will demonstrate that Rolph's assault on monetary obstacle failed because he falsely equated monetary deflation with backward shifting of excise taxes. Still more recently, Richard A. Musgrave diagnosed this problem as simply an aspect of distinction between absolute and relative prices. As shown above, he asserted, incidence depends on changes in relative price, and these are independent of change in absolute prices or price levels.4 Musgrave's proposed solution was to relegate changes in absolute prices and in price level to domain of the money supply and to reserve tax-induced changes in relative prices as hunting ground for an independent theory of incidence. ' I am greatly indebted to Mr. Roland N. McKean and Professors Howard S. Ellis, Bernard F. Haley, Milton Friedman, and James M. Buchanan for their helpful criticisms and suggestions at various stages in preparation of this paper.