In conversations about real estate, you often hear that the seller pays the closing costs, typically meaning they cover the realtor commissions when a home is sold. However, this statement can be misleading from an economic perspective. Just because the seller is legally responsible for certain costs doesn’t necessarily mean they bear the economic burden of those costs.
The legal incidence of a tax or cost refers to who is required by law or contract to pay it – in other words, who must physically write the check. By contrast, the economic incidence refers to who actually bears the cost once prices and behavior in the market adjust. These two can differ and often do.
A simple example
Consider a house with a true market value of $300,000. The owner wants to sell it and finds a buyer willing to pay that amount. Ignoring transaction costs for now, the seller hands over ownership of the house, and the buyer pays $300,000 in cash, ending up with a $300,000 house and $300,000 less in cash. The seller no longer owns the house but gains $300,000 in cash.
Now suppose the transaction includes a 5% realtor commission, and the seller is legally obligated to pay it. In that case, the seller still transfers the house, and the buyer still pays $300,000, but now the seller pays 5% of the sale price – $15,000 – to the realtor, ending up with $285,000 in cash, while the buyer still pays $300,000. In this case, the seller bears both the legal and economic incidence of the cost.
Obviously, the seller isn’t thrilled about effectively netting only $285,000 on a $300,000 house. Anticipating this, they raise the listing price to approximately $315,800. Now, when the house sells, the buyer pays $315,800, and the seller pays 5% of that amount – about $15,800 – to the realtor. The seller is left with $300,000 in cash after the commission, effectively recovering the full market value of the house.
In this revised case, although the seller still makes the legal payment to the realtor, the buyer bears the economic cost by paying more than the house’s underlying value. The economic incidence has shifted from the seller to the buyer.
Who bears the cost?
Who ultimately bears the cost depends on how sensitive buyers and sellers are to price changes – that is, on the price elasticity of demand and supply.
When buyers aren’t too price-sensitive (for example, because they’re in a rush or housing is scarce), sellers can raise prices to cover their own costs, and buyers will likely still do the deal, even at a premium. In this case, the buyer bears more of the cost.
However, if buyers are highly price-sensitive (like during a market slowdown or when mortgage rates are high), sellers might have to reduce the price or cover additional costs themselves to make the deal attractive. In this case, the seller both legally pays the commission and bears most of the economic burden.
The seller’s ability to pass costs along also depends on how easily more homes can come onto the market. If lots of sellers are competing or new homes can be built quickly, buyers have more options, while sellers have less leverage. However, if housing supply is limited (due to zoning rules, construction delays, or other constraints), sellers may be better positioned to shift more of the cost to buyers.
In short, the economic burden falls on the side with less negotiating power, regardless of who formally pays the bill.
Conclusion
From an economic standpoint, the statement “the seller pays the closing costs” is largely a nominal or legal assignment. In competitive markets, costs are distributed based on elasticities and bargaining power, not just formal rules. While the seller may write the check, the buyer may end up footing the bill simply because of a higher purchase price.
