After the North Carolina House and Senate negotiators confirmed they agreed on the broad outline of a state budget for next year, the prospect of abolishing the state’s 2.5 percent corporate tax has moved one step closer to reality . An exit is already foreseen in the Senate budget, and key members of the House of Representatives have backed the idea.
North Carolina consumers should cheer for the prospect because corporate income tax makes many of the goods and services they buy more expensive.
Taxing corporate profits has always been a complicated, unfair, and inefficient way to increase government revenue. Don’t let the label fool you. A “company” is simply a bundle of contracts between individuals – investors, lenders, executives, employees, sellers, and consumers. Only people pay taxes. Legal abstractions cannot.
Politicians have always recognized this fundamental fact. In the American context, corporate income taxes were first introduced in the late 19th century to tax the incomes of wealthy households who owned the vast majority of corporate stocks and should therefore bear virtually all of the costs of a “corporate tax” in the form of lower dividends and capital gains.
Why not tax the rich directly? This was not yet legal for the federal government, and most states also lacked income taxes. However, after the constitutions were rewritten to correct this, most policy makers did not replace their corporate taxes with personal taxes. They kept both in the books.
The idea that only corporate shareholders bear the true costs of “corporate” taxes was initially somewhat more plausible when investors concentrated more on business opportunities close to home. However, as capital flowed more freely across state and national boundaries, shareholders found they could earn higher after-tax returns on their funds in places with lower corporate taxes.
Other parties to the bundle of corporate contracts found themselves less able to circumvent tax jurisdiction. It is very costly for workers to switch to another job. And not all goods are sold to such an extent that consumers can buy from vendors far away. The demand by workers for jobs and by consumers for goods can be price inelastic, in other words, relative to investors’ demand for returns.
So when economists examine the actual incidence of corporate taxes – rather than just looking at the legally taxable party, the company – they try to estimate the relative proportions of shareholders with lower returns, workers with lower wages, and consumers paying higher prices.
When governments tax corporate income, all three things certainly happen to some extent. But progressives usually claim that shareholders pay three-quarters or more of the cost. This is difficult to reconcile with the empirical evidence, as Tax Foundation economist Stephen Entin noted in 2017. Shareholders almost certainly pay less than half the cost of corporate taxes, and Entin believes the real stake is around 30%. A recent study by three French scientists puts the investor share at 25%.
The remaining corporate income tax burden is not just that workers earn lower wages (partly due to lower corporate investment in productivity-enhancing capital goods). It also consists of (mostly) workers who act as consumers and pay more for goods and services than they would otherwise.
Another recently published paper shows this latter effect. An April 2020 study by researchers at Northwestern University, the University of Chicago, and the City University of Hong Kong found that “approximately 31% of the corporate tax burden falls on consumers, suggesting that the models used by policymakers are the corporation tax burden on consumers clearly underestimate “. . “
North Carolina has steadily lowered its corporate tax rate for nearly a decade. At 2.5%, it has the lowest tax rate of any state that tax corporate income. A complete exit in the next few years will bring economic benefits well above the apparent fiscal costs. We will attract more investment and create more jobs at higher wages. And yes, consumers are paying lower prices.
John Hood is a board member of the John Locke Foundation and the author of the new novel Mountain Folk, a historical fantasy set during the American Revolution (MountainFolkBook.com).