As the basic theory predicts

Economists tend to think that the corporate tax burden is shared between labour and capital, but even among researchers in the field there is substantial disagreement over how much of the burden is shifted to workers. This column exploits variations in local business tax rates in Germany to identify the corporate tax incidence on wages. On average, more than half of the corporate tax burden is passed onto workers, implying a reduced overall progressivity of the German tax system.

The smaller the economy relative to the world economy, the more mobile capital is, the more the burden of corporate taxation will fall upon labour.

Germany’s smaller than the US, capital is more mobile (think EU Single Market), the burden on labour is heavier than in the US.

20 thoughts on “As the basic theory predicts”

  1. Bloke in North Dorset

    Interestingly it looks like that successful German economy has corporate tax competition within the country. Could, of course, be correlation, but worth considering?

    I’ll bet we still can’t get the none believers on the left to understand this – there’s none so malicious as those who will not see:

    “We show that higher taxes reduce wages most for the low-skilled, for women, and for young workers. These results qualify the widespread view that the corporate income tax is highly progressive.”

  2. BiND,
    I was going to quote that sentence myself. Not only is half the burden falling onto workers, but it’s falling disproportionately onto the lower paid workers.

    I’ve explained this to friends until I’m blue in the face, but they just refuse to see it.

  3. This is, emphatically, not what I understand * the Courageous State and the Joy of Tax say.

    * based on comments I have read from those who have read the originals – I haven’t.

  4. We assume that a capitalist, profit seeking, firm is already dinging both suppliers and consumers as much as it possibly can. Thus the presence or not of a profits tax doesn’t change either set of prices.

    Sure, if you want to go to third level effects, then both do pay. Less investment, the second level effect, will lead to less production and fewer opportunities for supply. But we tend not to burrow that deep.

  5. “We assume that a capitalist, profit seeking, firm is already dinging both suppliers and consumers as much as it possibly can. Thus the presence or not of a profits tax doesn’t change either set of prices.”

    That seems illogical to me. Granted a new tax on one firm doesn’t allow it to raise prices, but a new tax on it and all its competitors does. Because if they all raise prices their relative competitive positions don’t change. Naturally there might be some substitution effects to attenuate the rises, and some reduction in total demand for their gewgaws, but the price rises will still exist, won’t they?

  6. That is true of certain taxes. VAT for example. Quite so.

    The effect of a profits tax is that the after tax return to investment falls, thus there is less investment (why not consume instead of save?) and the effects flow from that. I agree entirely that at the end of the process consumers are worse off, as are suppliers, but that’s further down the iterations.

  7. The corporate capture of this thread proves everything I’ve read on the Tax Research UK blog is true.

    P.S. I’ve had a liquid lunch.

  8. At a guess, looks like the effect on prices/customers is due to when the tax is levied; duties/tariffs levied before the customer transacts feed into prices, since the cost of them is already known, but profits tax is levied after the customer transacts, possibly at an unknown price, so can’t be adequately costed.

  9. “at the end of the process consumers are worse off, as are suppliers, but that’s further down the iterations.” Being further down the iterations presumably doesn’t guarantee that the effect is negligible though? In terms of their capital:labour distinction, could it be fair to assert that the bit they attributed to capital would in fact be shared between consumers, suppliers and capitalists, or is that too sweeping?

  10. We tend to stop at second order effects, leaving third order alone. It’s a bit like counting cousins – at 16 th cousins the entirety of Europe is related. Third and fourth order effects basically mean “the whole economy”

  11. “Why only capital and labour? Do customers pay none? Suppliers?”

    My still forming opinion is that it depends on the market conditions. For a business that operates in a relatively free market, like food service, competing businesses will cut labor expenses before prices, costing anyone that raises prices market share. The businesses that can pass prices on to customers are the ones without competition, like prescription drug manufacturers.

    I have further refinements that I think might fit. For now, I just would like feedback on this point.

    Tim,

    If a third or fourth order effect is going to cause a recession, shouldn’t we be looking for it?

    Here is one simplistic scenario:

    Let’s say we decide to impose tariffs(We’ll use solar panels as they have been in the news. The first order effect is that domestic suppliers gain market share. One second order effect is that solar panel prices now increase, leading to job loses for solar installers. The third order that follows is a collapse of solar stock prices. This combines with other market adjustments, given us a recession as our fourth order effect.

    What mistakes did I make?

  12. I’m not sure I agree that all companies being taxed extra > change to supply / demand curve > must affect consumers (ie may pay more) (and / or suppliers) is really a good analogy for 16th cousins or “the whole economy”?

    “Higher prices for consumers” (etc) to me looks at least somewhat as relevant as the argument “changes in taxes impact *only* on either capital or labour”? At least to the extent of quoting labour/capital as standard theory?

    But thanks anyway, I’ve learnt something new.

  13. LY

    “For a business that operates in a relatively free market, like food service, competing businesses will cut labor expenses before prices, costing anyone that raises prices market share.”

    A tax change affects all producers. Simply take it to extreme. Costs quadruple, for every producer.

    Prices aren’t going to stay the same, no matter how competitive that market is?

  14. @Geoffers, October 10, 2017 at 12:04 pm

    …but it’s falling disproportionately onto the lower paid workers.

    I’ve explained this to friends until I’m blue in the face, but they just refuse to see it.

    Because they are the least valued and most easily replaced?

  15. PY,

    Yes, all suppliers are affected. All suppliers don’t have to take the same actions though. The business that transfers cost to labor should be* more competitive than the business that tries to pass costs on to customers.

    * We all know the real world isn’t a simple model and other factors come into play.

  16. But then why didn’t they (the supplier reducing wages) do it before – and make out like bandits. Competition for labour? Nothing changed there as regards that single variable.

    You are right, and which is the point Tim is making, ie nth order etc. But tax affects all (at least in a single jurisdiction), and hence should be simpler to understand.

  17. Let’s look at this from a different perspective.

    Imagine yourself going to an area that has been affected by a hurricane. You are handing out bottles of water. Other people are also handing out bottles of water. Do you hand a bottle of water to someone that already received a bottle from another distributor, or do you give it to someone that doesn’t yet have a bottle of water? My sample of two has both of us giving the bottle to the person that hasn’t yet received one.

    Now, let’s think about the business owner. With no tax, you have to pay your employees x amount or they starve. Dead workers aren’t very productive. With tax, government is now picking up the tab. Businesses won’t pay a living wage because, why bother if someone else is already doing it.

    This doesn’t just apply to low income people. Welfare for the wealthy just comes in different forms.

  18. LY;

    “With no tax, you have to pay your employees x amount or they starve.”

    True enough;

    “With tax, government is now picking up the tab.”

    Not true enough. Yer actual business owner has no way of knowing what the tax might be spent on. He only knows that he no longer has the money.

    Over time, he might be able to assume that because government gave workers food in the previous X periods, they’ll do it again this period, but that’s the only evidence he’s got.

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