Tax incidence refers to the analysis of how the burden of a tax is distributed among different participants in an economy — whether it falls on consumers, producers, or both. It helps understand who ultimately pays for a tax, regardless of who is legally responsible for remitting it to the government.

In simple terms, tax incidence examines the real impact of a tax on prices, income, and profits. For example, when the government imposes a tax on goods or services, the seller may increase prices to offset the tax burden. However, if demand is elastic and consumers are price-sensitive, the producer may have to bear most of the tax to avoid losing customers. Conversely, when demand is inelastic, consumers tend to absorb a larger portion of the tax through higher prices.

The incidence of tax depends on the relative elasticity of demand and supply. If supply is more elastic than demand, consumers bear a higher share of the tax burden, and vice versa. This concept is crucial in understanding how taxation policies affect market behavior, consumer spending, and business profitability.

In the context of financial markets, tax incidence also applies to investment gains and transaction taxes. Investors may experience indirect tax effects through changes in market prices or reduced returns. Policymakers use tax incidence studies to design fair and efficient tax systems that minimize distortion and ensure equitable distribution.

Overall, understanding tax incidence is essential for investors, economists, and businesses to evaluate how taxes influence economic decisions and welfare. It provides valuable insight into how tax policies shape both microeconomic and macroeconomic outcomes.