Ritchie on corporation tax incidence

And whilst still on corporation tax let’s put to bed that age old (well, rather more recent, actually) myth that the cost of corporation tax is largely paid by labour. This myth is almost entirely the work of Prof Mike Devereux at Oxford who studied corporate tax increases (themselves a rare phenomenon) and suggested when they occur wages paid fall. He forgot two things. First he didn’t notice countries did in the past only increase tax rates when they were in economic distress, of which falling wages are a sure sign. Second, Devereux forgot to check if the relationship he supposedly found worked in reverse i.e. did wages increase when corporation tax rates fell? Real wages have fallen steadily since 2008 and so have corporation tax rates. If Devereux had been right then falling tax rates should have boosted wages, but they very clearly have not. The evidence of any significant link between tax rates and corporate tax dates has been shattered for good. Devereux should have realised that correlation does not necessarily indicate causation.

Ritchie is rather ignoring something here. That Deveraux has provided an estimate of how the corporate tax burden is split between labour and capital in the UK is true.

But that is all that is true. Ritchie is so ignorant of economics that he assumes that the basic theory started with Deveraux: not so, it is only one paper providing one estimate.

The first four results from a Google search for “incidence of corporate income tax” (I stop there because the fifth is me).

Uwe Reinhardt in the NYT:

The earliest formal general equilibrium model, published in 1962 by a University of Chicago economist, Arnold C. Harberger, in the Journal of Political Economy, assumed a closed economy. In that model, the burden of the corporate income tax ultimately fell entirely on the owners of capital.

When the model was modified as an open economy in which capital in the taxed country can escape by flowing abroad to untaxed or lower-taxed countries, some or all of the burden of the corporate income tax shifted to labor. Under the assumption of perfect international capital mobility and perfect substitutability of imported goods and services for all domestically produced goods and services, labor would then bear the entire corporate income tax, because labor is the only immobile factor than cannot escape the tax.

The point is made before Deveraux was out of short trousers.

The Wikipedia entry:

Similarly, taxes on a business that can easily be relocated are likely be borne almost entirely by the residents of the taxing jurisdiction and not the owners of the business.

A 2005 paper from Alan Auerbach:

Finally, while exploring many extensions of the Harberger model, I have devoted little
attention to one of that model’s important omissions, the impact of corporate income taxes on
capital accumulation. But the implications are clear. For taxes on capital income, in general, we
would expect an increase in the effective tax rate on new saving and investment to reduce capital
accumulation. The resulting decline in the capital-labor ratio would increase before-tax returns
to capital and lead to a fall in wages, thus partially shifting the tax burden from capital to labor.
This analysis would apply to the corporate tax as well, but only to the extent that the corporate
income tax represents a tax on new saving and investment. The shift in the corporate tax burden
from capital to labor can proceed only if it is first shifted from shareholders.

The Concise Encyclopedia of Economics:

Modern economic opinion is divided on the incidence of the corporate income tax, but few economists today believe its burden falls entirely on the owners of capital. The latest thinking is that, since capital is mobile, it will flow to investments that produce the highest after-tax returns. The corporate income tax raises the cost of capital and reduces after-tax returns in the corporate sector, and thus leads to a migration of capital into noncorporate or taxexempt sectors of the economy. This migration has two effects: it lowers the supply of capital available to corporations, and it causes a reduction in rates of return in the noncorporate sector as capital becomes more plentiful there. The ultimate effect, therefore, is to lower returns for all owners of capital across the economy. One important result of this capital migration is that the burden of the corporate income tax, over time, shifts to workers: with a smaller capital stock to employ, workers are less productive and earn lower real wages. In a 1996 survey, public finance economists were asked to estimate what percentage of the corporate income tax in the United States was ultimately borne by owners of capital. While their answers varied, the average response was 41 percent, meaning that the professional consensus is that more than half the burden is eventually shifted from owners of capital to workers or other groups.

And the Tax Policy Centre:

In the past several years, researchers have attempted to estimate the incidence of
the corporate income tax empirically. The primary approach used in empirical papers has
been to examine cross-country variation in the corporate tax rate over time and measure
subsequent changes in wage rates. All of the recent empirical papers have found that corporate taxes lead to depressed wages, but critics have questioned the validity of the
empirical methodology. To date, there remains little, if any, consensus about who bears
the burden of the corporate tax.

That last is particularly interesting, don’t you think? Empricial papers find the very effect that Ritchie is looking for?

Or, in other words, Ritchie is spouting nonsense on this subject.