On the incidence of corporation tax

One for Ritchie and points left.

A central tenet of public finance, however, is that the entity that has the legal obligation to pay a tax is not necessarily the one that bears the burden. For example, payroll taxes are levied on firms, but we know that they are mostly borne by workers. Raise payroll taxes, and firms cut wages. Lower payroll taxes, and most firms will pass on a pay rise.

The GST is another case in which the burden of a tax doesn’t fall on the entity that pays the tax bill. Although the law says that the tax is levied on those who supply goods and services, it is customers who end up bearing most of the burden.

Which brings us to company taxes. For decades, economists have argued over how the burden of company taxes are shared between investors, employees and customers. In the short-term, it is difficult to change prices and wages, so a higher company tax rate will be paid in the first instance by shareholders.

But over time, the burden is likely to shift. Investors are a footloose bunch, with the ability to shift their money into sectors like real estate where they can avoid company taxes. For an open economy like Australia’s, higher corporate income taxes will lead investors to buy foreign shares instead (which is why small countries have been cutting company tax rates over recent decades). To keep their investors, companies may respond to the tax rise by raising revenue and cutting costs.

What will a company tax rise do to prices? While the evidence is thin, theory suggests that companies will be most likely to put up prices on consumers when they do not face competition from importers. So an Australian shoe manufacturer (do we have any left?) may be unable to shift the burden to consumers. But a fast food outlet will have greater capacity to raise prices.

In the case of wages, the empirical evidence is stronger. In a recent review of the literature, William Gentry (Williams College) concludes that most of the impact of a corporate income tax rise falls on workers. Increase company taxes by 10 percentage points, and wages fall by 6-10 percent.

Please note \”a central tenet\”. This is not some right wing or neo-liberal invention. It\’s a basic truth about how the world operates.

That linked paper?

Office of Tax Analysis
US Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Abstract:

Who ultimately bears the burden of the corporate income tax plays an important role in the distributional analysis of tax policy. Distributional tables often assume that the incidence of the corporate income tax falls on the owners of capital but there is considerable uncertainty amongst economists about who bears the burden of the corporate income tax. This paper reviews the evidence on the incidence of the corporate income tax, especially in light of recent empirical studies that focus on the relationship between the corporate income tax and wages. While further research is necessary to draw definitive conclusions, these studies suggest that labor may bear a substantial burden from the corporate income tax. These empirical results are consistent with computable general equilibrium models based on an open economy in which a single country sets its tax policy independently of other countries; in these models, assumptions that capital is mobile and consumers are willing to substitute tradable goods produced in different countries imply that labor can bear more of the incidence of the corporate tax than capital bears. Evidence on the degree of capital mobility across countries and the sensitivity of corporate investment to changes in tax policy also corroborate the possibility that the corporate income tax lowers wages by reducing the productivity of the work force. In addition to changes in productivity associated with changes in capital intensity, labor may also bear part of the corporate income tax if wages are determined in a bargaining framework since the corporate income tax may change the equilibrium wage bargain. Overall, the recent empirical evidence, the open economy computable general equilibrium models of tax incidence, and the sensitivity of the amount of capital investment within a country suggest reconsidering the assumption that the corporate income tax falls on the owners of capital; labor may bear a substantial portion of the burden from the corporate income tax.

This isn\’t the sort of thing that is overturned by a retired accountant scribbling on the back of an envelope.

5 comments on “On the incidence of corporation tax

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  3. err, you said it yourself. “While further research is necessary to draw definitive conclusions, these studies suggest that ” – this is precisely the sort of thing that is overturned easily. You have even asserted that bankers don’t mind being taxed, to support your incidence argument about incidence (though you sensibly declined to engage with Evelyn’s argument that they don’t like being taxed, out of concern for ordinary folk.) And when challenged on your shaky argument, Mr. Worstall, you then turn to these hypothetical studies, as if appealing to a higher authority. Your incidence argument is also premised on the notion that tax revenues go up in smoke. They don’t. As I’ve asserted before, tax cuts have “incidence” too – just because they’re more diffuse and harder to notice, it doesn’t mean this doesn’t exist. And you’ve done nothing at all to rebut this point.

    Tim adds: These are not hypothetical studies. They are empirical ones. They are attempting to see what actually happens out there in the real world. Now, if you want to argue that they’re wrong then go ahead. And please do show me some similar empirical studies which show the opposite. I’d be delighted to read them.

    But until you do you’re merely hand waving.

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