tax incidence – the _

[2427] Are telcos actually raising prepaid rates?

Consider a tax imposed on a producer in a transaction with its customer. In other words, the producer pays the tax. Does the tax burden fall on the producer exclusively? Or is it shared? Or really, is it a tax on the consumer?

This refers to the controversy regarding the passing of the 6% service tax from telecommunication companies to consumers of prepaid telecommunication services. Telcos have been absorbing the tax previously and now they have decided not to do that anymore. The service tax was supposed to be paid by the consumer anyway. It is a service tax, which is a consumption tax.

What does economics have to say about the passing? What is the welfare effect?

Laypersons might find the answer outrageously shocking: it does not matter who pays what. Whoever the taxpayer, the actual tax burden share between the producer and the consumer is unchanged.

There is a concept in microeconomics called tax incidence. According to it, regardless who pays it, the actual burden depends on elasticity. In layman terms, the most desperate between the producer and the consumer will suffer the larger burden of taxation.

Here is a clearer explanation. While the telcos officially pay for the tax and if the consumer is insensitive to price change relative to the telcos, the truth is that telcos are passing the tax to the consumer in form of higher prepaid service price. If it is the telcos which are insensitive to price change, then the telcos will actually suffer the larger tax burden.

But there is a problem here, I think.

If the tax is passed to the consumer without change in elasticity, the new rate for prepaid service should be cheaper to account for tax incidence. This assumes that the rate prior to the passing already accounts for the absorption of the service tax, which it should in my opinion. So, RM10, for example, should be able to buy the same amount of minutes before and after the passing.

But if not, if customer will have to pay more for the same minutes after the passing (meaning, the rate for prepaid service remain unchanged after the tax is passed), then it is possible that the telecommunication companies are taking advantage of the situation by actually raising its price stealthily.

That has to be it. Think of it. The tax incidence theory has to hold. The government will receive the same amount of tax but the consumer will have to pay more overall. Somebody is gaining something.

That is right. I am suspecting that the telcos are not only passing the tax (which the passing itself is superficial according the tax incidence concept), they are raising the prepaid rates as well.

[2362] Consumer subsidy, corporate subsidy and… tax incidence

There is an argument in the Malaysian political sphere that goes like this: reduce corporate subsidy first and only then reduce consumer subsidy if need be.

It is a fair point. Yet, the validity of the point depends on which corporate subsidy.

This is due the tax incidence concept. I will not thoroughly go into it but I will summarily state that it does not matter who is taxed or subsidized. Whether it is the producer or the consumer, the answer to the question whose welfare will decrease or increase depends on a person’s — producer and consumer alike — sensitivity to price change.

If subsidy to sugar producer is removed, it is very likely that welfare of a person will go down the same way how a consumer subsidy removal will reduce the same welfare (assuming it is welfare enhancing to the consumers in the first place). That is to say that the removal of subsidy for sugar producer has the same welfare effect as the removal of subsidy for sugar consumer.

To put it more concretely, say a subsidy enhances consumer welfare and both producer and consumer are subsidized at the same time. If you reduce consumer subsidy, the consumer’s welfare will decrease. If you reduce producer subsidy, the consumer’s welfare will decrease all the same.

Removal of subsidy from anybody does not shift the welfare effect from one side to the other. It merely increases or reduces the effect.

This is a point those arguing “corporate subsidy first” need to be mindful because they are the ones whom oppose increase in prices and the eventual reduction in consumer welfare.