Tax Wedge vs Tax Incidence

A tax wedge is the gap a per-unit tax drives between the price buyers pay and the price sellers receive, equal to the tax per unit at the new quantity.

When a tax is imposed, buyers pay one price and sellers keep a lower one; the vertical distance between them is the wedge, equal to the tax per unit. The wedge reduces the quantity traded below the efficient level and creates deadweight loss (the triangle whose base is the lost quantity and height is the wedge). How the wedge splits into buyer and seller burden depends on relative elasticities, but the size of the wedge itself equals the statutory tax per unit regardless of who legally pays it.

Tax incidence refers to the distribution of the tax burden between buyers and sellers.

The incidence of a tax depends on the relative elasticities of supply and demand. If demand is more inelastic than supply, consumers bear a larger share of the tax burden. If supply is more inelastic than demand, producers bear a larger share.