Corporate Tax

Who bears the corporate revenue tax burden?

May 13, 2021

JOE BIDEN wants to rebuild America, and he believes American companies can help pay the bill. At the heart of the president’s major infrastructure investment is a plan to raise the corporate income tax rate from 21% to 28% (although he has hinted he could be content with less). Although the government’s tax proposals aim to solve the problem that “the front runners are not doing their part,” opponents warn that the corporate tax hikes will not only fall on wealthy shareholders, but also on the wage stacks of working people, for whom the president claims to be advocating . Indeed, workers often bear part of the burden of corporate tax increases – although how much of it should be understood remains a matter of concern for economists. Still, the details of Mr Biden’s tax plans suggest they might prove more worker-friendly than the usual attempt to squeeze juice out of Apple.

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All other things being equal, a tax on corporate profits should hit shareholders – a group richer than the general population – by diminishing the money available for dividend payments or lowering the value of shares. But other things are never the same. Companies invariably react to new taxes in order to minimize their costs. Depending on how you want to evade the tax, part of the burden can be passed on to others. A seminal paper published in 1962 by Arnold Harberger, an economist, suggested that such a floundering of capital owners would likely not shift the cost of a corporation tax to other means of production. He envisioned an economy with only two sectors, corporate and non-corporate, and then assumed that the income of the former would be taxed. Capital, he argued, should be shifted from the corporate sector to the non-corporate sector (consisting of partnerships and other types of business). As a result, the average return on investment in non-core companies should decrease, reflecting the flow of resources into lower-yielding types of production that are only attractive because of the sector’s comparatively favorable tax status. Businesses could shift some of the corporate tax burden on owners of capital in other parts of the economy, but not on workers.

However, Mr. Harberger’s model made a number of simplifying assumptions. For example, he assumed that the markets were completely competitive. In practice, companies can enjoy market power either through workers (in which case some of the tax costs can be absorbed by wages, not just profits) or consumers (who may face higher prices). Perhaps most importantly, Mr Harberger assumes that the economy in question is closed. In practice, capital is relatively mobile across national borders – and intangible forms such as intellectual property in particular – while other factors of production such as labor are not. An increase in corporate tax in one country could then encourage capital owners to move abroad, reducing the amount of capital per worker domestically and potentially reducing workers’ productivity and wages. In fact, research by Laurence Kotlikoff of Boston University and Lawrence Summers of Harvard University showed that in very small, very open economies, the burden of corporate tax increases falls almost entirely on work.

The size of an economy and its openness to capital flows are just two of the five factors that most affect an economic model’s conclusions about the frequency of corporate tax changes, argued Jennifer Gravelle Stratton, then of the Congressional Budget Office, in a published paper (Size matters because Changes in the capital stock of larger economies have a greater impact on global ROI.) Another factor is how seamlessly production can be moved abroad in response to tax changes. Similarly, the ease with which capital can be used to replace labor determines how much workers’ economic prospects will be affected if capital escapes (or threatens) the country. And who pays the most depends crucially on how capital-intensive the corporate sector is: the higher the capital per employee, the more each employee suffers when a corporate tax hike affects where companies spend their capital.

In other words, figuring out the likely effects of a corporate tax change is complicated and messy. Empirical studies show just that. A paper published in 2015 by Kevin Hassett, later chairman of President Donald Trump’s Council of Economic Advisers, and Aparna Mathur of the American Enterprise Institute, a think tank, concluded that an increase in the corporate tax rate of 1 % associated with this is a 0.5% decrease in wages: a result that means that more than 100% of the corporate tax burden goes to employees. At the other end of the scale, an economics study by the OECD, a club of the most wealthy countries, by Kimberly Clausing, an economist at Reed College who is now Assistant Secretary of the Treasury, found no clear link between corporate taxes and wages.

Pass the buck

Other studies suggest that the burden is shared. An analysis of the German economy published in 2017, in which the distribution of its costs was assessed using different local trade tax rates, came to the conclusion that more than half of the burden is borne by the employees. Economists summarizing the literature often find that the work bears some, but not all, of the corporate tax burden – perhaps around 40% – while occasionally admitting that the actual number depends heavily on the context of a particular tax measure.

However, the context can change. The narrowing of the differences in corporate tax rates between countries gives companies less leeway to pass the tax burden of moving production abroad onto workers. The Biden government’s proposal for a global minimum rate is largely aimed at companies using accounting tricks to book profits in tax havens. However, it should also discourage efforts by governments to lure production by undercutting tax rates in other countries. That would ensure that more corporation tax is paid where it is intended.

This article appeared in the Finance & Economics section of the print edition under the heading “When the Inc is up and running”

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