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A recent article in the Star Tribune (Thursday, July 23) examined the new Minnesota tax credits for educational spending. In the debate over education tax credits, a significant economic aspect of the tax process known as "tax incidence" has generally been ignored. Yet a more thorough examination of the tax incidence of educational subsidies might give the public a better understanding of who truly benefits from this subsidy. Tax incidence is the study of who really pays for a tax or benefits from a subsidy. To demonstrate the concept of tax incidence, suppose that the government places a 10 cent tax upon a gallon of gasoline that normally costs $1.00. One of two things might happen. First, the gas station could try to pass the entire tax on to the consumer so that the consumer now pays $1.10 per gallon. In this case the entire burden of the tax, in other words the entire tax incidence, would fall upon the customer. On the other hand, the station could swallow the tax and continue to charge only $1.00 for the gasoline despite the new tax. In this case the store bears the entire tax incidence. Economists believe that for most goods in the real world, the true tax incidence lies somewhere in between these two extremes. In other words, both consumers and suppliers end up paying a portion of the tax. A 10 cent tax on gasoline might result in a price of $1.05 per gallon so that both the consumer and the gas station pay for half of the tax. The exact portion that each party pays is dependant upon how much consumers and producers are willing to change the amounts they demand and supply based on changes in prices. Tax incidence becomes very important when the purpose of the tax or subsidy is to benefit or penalize a particular group. It is entirely possible that a 10 cent increase in gasoline taxes designed to penalize drivers of gas guzzlers could instead serve mainly to harm gas station owners if gas station owners end up bearing the majority of the tax incidence for the 10 cent increase. Similarly, a tax credit designed to help families with school-age children may instead only serve to benefit providers of educational services, and therefore these credits would not serve the purpose for which they were designed. Subsidies, such as the new education tax credits, work in much the same way as taxes with the benefits from these subsidies being split between the consumers who receive the credits and the suppliers who provide educational services. As families receive subsidies for education, suppliers of educational services such as summer language camps and private tutors have the incentive to raise their prices since larger numbers of people can now afford their services. Part of the benefit goes to the families in the form of a tax rebate while part of the benefit goes to educational service providers who receive higher prices. Several aspects of the market for educational services would lead many economists to believe that service providers will receive the lion's share of the benefits from these subsidies. The primary way that the State of Minnesota can ensure that families
rather than service providers receive the benefits from these the new tax
credits is to limit the credits to the truly needy. By limiting the size
of the population receiving credits, the government limits the ability of
service providers to raise their prices. A broad-based tax credit for
education that is available to all families may serve only to make
educators rich at the expense of tax-payers.
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