Who really pays an indirect tax: why the more inelastic side of the market bears more of it, with the extremes and the calculations.
Fuel duty is a specific tax: a fixed amount on each litre of petrol and diesel, with VAT charged on top. It was cut by 5p a litre in March 2022, to 52.95p, and has stayed there. The 2025 Budget planned to put it back up in stages from September 2026, but in May 2026 the government postponed the rise, keeping the cut until the end of 2026.
Every rise in fuel duty makes headlines about drivers paying more. Why drivers, and not the oil companies?
Sources: HMRC, Fuel duty rates 2026 to 2027; RAC Foundation, Fuel duty rise postponed (20 May 2026).
The formal incidence of a tax is who hands it to the government: for fuel duty, the fuel companies. The economic incidence is who really bears it, through a higher price for buyers or a lower price kept by sellers.
The rule: the more inelastic side of the market bears more of the tax. If buyers cannot cut back, sellers can pass the tax on. If buyers have plenty of substitutes, sellers have to absorb it.
To see this, keep everything the same (ceteris paribus): the same supply curve, the same £3 tax and the same starting point. Only the slope of demand changes.
The government adds 10p to the tax on every litre of petrol.
Most drivers cannot easily drive less, at least not in the next few months.
Who will pay most of the 10p?
When buyers cannot easily cut back, sellers can raise the price without losing many sales. So most of the tax is passed on. The side of the market that can respond least to price ends up paying most.
Here is the market before the tax, at P1 and Q1, and supply shifted up by a £3 specific tax. The question is how far the price rises, and that depends on demand.
First, inelastic demand: steep, like fuel in the short run. When supply shifts up, quantity barely falls, so the price rises a long way: from £6 to £8.40.
Producers keep £8.40 minus £3, which is £5.40. Split the revenue at P1. Consumers bear £2.40 of every £3, the big blue block. Producers bear 60p. Consumers carry most of the tax because they keep buying.
Check: With inelastic demand, producers keep £5.40 a unit. What share of the £3 tax do consumers bear?
Consumers pay £8.40 instead of £6: £2.40 more. Producers keep £5.40 instead of £6: £0.60 less. So consumers bear 80%.
Now the same tax with elastic demand: flat, like one brand of crisps when there are plenty of others. Raise the price and buyers switch, so quantity falls a long way and the price rises only a little: from £6 to £7.20.
Producers keep £7.20 minus £3, which is £4.20. Now the green block is the bigger one: producers bear £1.80 of every £3, consumers £1.20. When buyers can walk away, sellers have to swallow most of the tax.
Check: With elastic demand, who bears most of the tax?
Consumers pay £1.20 more. Producers keep £7.20 − £3 = £4.20: £1.80 less. So producers bear 60% of the tax.
The extremes make the rule clear. With perfectly inelastic demand, a vertical line, quantity cannot fall at all, so the price rises by the whole £3 and consumers bear all of it. With perfectly elastic demand, a horizontal line, the price cannot rise at all, so producers bear all of it.
Check: If demand were perfectly elastic (horizontal), who would bear the tax?
With horizontal demand the price cannot rise at all without losing every sale, so producers absorb the whole tax and the quantity falls sharply.
Now look at supply instead.
Check: Keep demand the same but make supply more elastic: firms can easily cut output rather than accept a lower price. Who now bears a bigger share of the tax?
If firms can cut output easily, they will not accept a much lower price, so the price consumers pay has to rise by more of the tax.
The same works for supply. The more elastic supply is, the more of the tax falls on consumers, because producers can cut output easily rather than accept a lower price. The rule in one line: whichever side is more inelastic bears more of the tax.
They put it at the old price, P1, as if producers lose nothing. Producers hand the whole tax over out of P2, so they keep P2 minus the tax, which is on the original supply curve below Q2.
Explain why consumers bear most of a tax on petrol.
Demand for petrol is price inelastic, at least in the short run. Most drivers need their cars to get to work and there are few close substitutes, so they keep buying even when the price rises.
[Diagram: a steep demand curve and S + tax parallel to S. A big rise from P1 to P2, a small fall from Q1 to Q2, with the consumers’ share of the revenue above P1 much larger than the producers’ share below it.]
Fuel duty shifts supply vertically up by the tax. Because demand is inelastic, quantity falls only a little, so fuel companies can raise the price by most of the tax without losing many sales. Consumers pay P2, much higher than P1, while producers keep P2 minus the tax, only a little below P1. So consumers bear most of the tax, even though the fuel companies hand it to the government.
**Evaluation:** demand becomes more elastic over time as drivers switch to electric cars, public transport or more efficient cars. Then more of any rise in duty would fall on producers, and less revenue would be raised.
Fuel duty rates: HM Revenue and Customs (gov.uk) and RAC Foundation, 2025 to 2026. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.