Tax Incidence: Why You Can’t Have a Free Stadium

A while back a friend of mine extolled a new stadium deal in Kansas City, MO because the Mayor, Kay Barnes, was able to raise the money to pay for the new stadium without raising taxes on Kansas City residents. The scheme: Charge hotel guests in the city a tax on their hotel rooms and charge those who rent cars a fee on their rental cars (my friend assumes that practically nobody stays in a hotel or rents a car in their own city). The beauty of this plan was that all the money to pay for the stadium was coming from those outside the city, and that people from KC would get to enjoy the stadium without having to contribute any tax dollars to the city coffers. As I hope to show you from the economic theory of tax incidence, this sentiment is only partially true, at best, and might be dead wrong at worst.

Spint Arena

The first thing we want to do is differentiate between who pays the tax and who bears the economic cost of the tax. This is known as the difference between the statutory burden and economic burden of taxation. The statutory incidence of a tax is simply the dollar amount the party who is legally responsible for collecting and remitting the tax to the government must pay. For example, the statutory incidence for the retail sales tax falls upon the vendor. Each taxing period, the vendor at your local convenience store must mail a check for some percentage of their sales to the state and local taxing authorities. In the case of the personal property tax, you, the property owner, bear the statutory burden of the tax because you are responsible for collecting the money (from yourself) and sending a check to the city.

The economic incidence of a tax is the actual change in the distribution of income due to a tax. In other words, it is a measure of the change in how truly worse of you are after a tax is imposed. The economic incidence and statutory incidence can differ substantially because the party who bears the statutory incidence can engage in tax shifting. In simple terms, the vendor (in the case of a sales tax) can raise their prices to help cover the tax. When you purchase a $1 pack of chewing gum, you expect to pay more than a dollar because you have to pay sales tax on top of the price of gum. In essence, the vendor is shifting the incidence of the tax to you. In reality, however, the vendor does not shift the whole tax to you, they also eat part of the cost of the tax themselves.

To see how this works, let’s walk through a simple tax example. Let us say that gasoline costs $3 per gallon, and there are no gas taxes. Now, in order to pay for more better office chairs in the state capitol building, the legislature imposes a $1 tax on gas that has to be remitted by the gas station. Since there is a $1 tax on gas, the gas station now receives $2 per gallon because they have to pay the gas tax. They are not able to stay in business sell gas at $2 per gallon, so to combat this, they raise prices. The key here is that you are not willing to pay $4 per gallon, so they cannot pass the whole tax onto the consumer. In the end, they settle on passing some of the tax on, and eating some of the cost of the tax. Let’s say hypothetically that the new price of gas is $3.40. In this example, the gas station is eating $0.60 and passing $0.40 onto the consumer. The point is that the gas station had a statutory incidence of $1, but an economic incidence of $0.60.

If we, instead, put the statutory incidence on the consumer–you have to pay the government $1 for each gallon of gas you buy, the result is exactly the same. You owe $1 for each gallon, so you try and lower your offer price for gas to $2 so that your out-of-pocket cost remains $3. Of course, we said earlier, that the gas station is not able to accept $2 per gallon, so you would need to pay a bit more. In the end, you would settle upon paying $2.40 cents per gallon plus the $1 tax–resulting in the same price as before, $3.40. In other words (here is the kicker) the economic incidence of the tax is the same regardless of who bears the statutory incidence. It does not matter who has to pay the tax, the change in economic welfare is the same for both (all) parties involved.

Now, let’s take this concept back to our stadium funded by the hotel tax. In this case, the statutory incidence is on the hotel. When they provide you with a room, they must remit the tax for that room. With our understanding of economic incidence, we know, however, that the hotel does not bear the entire cost of the tax, nor does the traveler. The economic cost of the tax is split between the hotel and the guest. This means that for a hotel tax, some the the tax is paid for by the out-of-town guest, and some of the tax is paid for by the local hotel. How much is determined by the two party’s relative willingness to pay the tax. If there is only one hotel in town and lots of people who want to stay there, then most (or all) of the tax can be passed onto the guest. On the other hand, in a convention town like KC, there may be a lot of hotels with not enough guest to fill them up. In this case, much of the tax must be borne by the local hotel.

Since we know the hotel has to pay part (or all) of the tax, we also should understand that the money to pay the tax comes out of its profits. This means there is less left over to pay the cleaning staff, front desk worker, waiters, cooks, and and pool lifeguards. All of these people tend to be local, so in reality, some of the tax is being paid by local residents of Kansas City. In other words, except in extreme circumstances, it is very unlikely to be true that the hotel tax would not tax local resident of Kansas City and only tax hotel guest. The point is that, as always in economics, there is no free lunch. Using taxes to pay for a stadium may be a good idea, or it may be a bad idea, but we know for sure that is tax dollars are used to pay for it, local residents are going to contribute some or all of those tax dollars no matter how the tax is structured.