Greg's Not Quite Right

Greg misses transition costs and disequilibrium effects in his analysis on tax incidence. He says it doesn't matter who is required to pay the tax, the final incidence is determined by supply and demand.

That's not quite right for a couple of reasons. First and foremost Illionis's requirement that the cost not be passed on to employees means that the payment shock falls on employers. There is a cost to changing the number of workers that a firm has or renegotiating wages.

If the firm cannot immediately pass the cost on to the workers then it must absorb the costs until the market re-equilibrates.

Furthermore, the labor market is prevented from reaching equilibrium in some cases. The most obvious is the minimum wage. This legislation effectively then raises the minimum wage and causes real effects.

In addition, my guess is that public employees are also affected. There is no particular reason to think that public employees are paid equal to their marginal product or that there is a smooth downward sloping labor demand curve. In this case there can be real effects for public employees.

The devil is details and the details are always messy.