WHO PAYS THE LUXURY TAX?

In 1990, Congress of USA adopted a new luxury tax on items such as yachts, private airplanes, furs, jewelry and expensive cars. The goal of the tax was to raise revenue from those who could most easily afford to pay. Because only rich could afford to buy, such extravagances, taxing luxuries seemed a logical way of taxing the rich.

2.Yet, when the forces of supply and demand took over, the outcome was quite different from the one Congress intended. Consider, for example, the market for yachts. The demand for yachts is quite elastic. A millionaire can easily not buy a yacht; she can use the money to buy a bigger house, take a European vacation, or leave a larger bequest to her heirs. By contrast, the supply of yachts is relatively inelastic, at least in the short run. Yacht factories are not easily converted to alternative uses, and workers who build yachts are not eager to change careers in response to changing market conditions.

3.Therefore, with elastic demand and inelastic supply, the burden of a tax falls largely on the suppliers. That is, a tax on yachts places a burden largely on the firms and workers who build yachts because they end up getting a significantly lower price for their product. The workers, however, are not wealthy. Thus, the burden of a luxury tax falls more on the middle class than on the rich.

4.The mistaken assumptions about the incidence of the luxury tax quickly became apparent after the tax went into effect. Suppliers of luxuries made their congressional representatives well aware of the economic hardship they experienced, and Congress repealed most of the luxury tax later.

Question:

In view of the above case study, explain with the help of diagram, the impact of tax on the demand and supply of luxury items like costly cars in India.