The Congressional Budget Office estimates that employees pay 25 percent of corporate tax.
President Biden suggests funding his infrastructure spending proposal by increasing the corporate tax rate from 21 percent to 28 percent. What difference will that make?
If virtually all economists can agree on one thing, it is this: corporations do not pay corporate income tax.
Why is that? A company is not a person. It’s a relationship – a relationship between workers, managers, shareholders, consumers, and others. You can tax relationships. But relationships don’t pay taxes.
Sales tax, for example, taxes a relationship between a buyer and a seller. But sales don’t pay taxes. People do. Sales tax must be borne by the buyer, the seller, or both. In competitive markets, economists assume that the buyer bears the full burden. This conclusion makes sense to most people, seeing that the tax is nominally added to the prices of the goods they buy at the checkout.
But what we see with our own eyes is not necessarily good economy. Take the wage tax. This is an income tax. But wages don’t pay taxes. The burden must fall on the buyer (the employer) or the seller (the employee) or both. In practice (and by law) half of the tax is deducted from the worker’s wages and the employer sends a check to the government for the full amount. So it looks like the employee pays half and the employer pays half.
However, careful studies by economists over many years show that this is not the case. The tax burden is not determined by who writes the check to the government. It is determined by how the market adapts to the tax. In this case, the evidence is quite convincing: the full burden rests with the workers. This means that for every dollar of wage tax the government levies, workers’ wages are one dollar lower than they would otherwise be.
With that in mind, let’s turn to corporate income tax. Who pays it With all the adjustments said and done, there are multiple candidates including consumers, employees and shareholders. How is the burden distributed among these three groups?
The surprising answer is that economists don’t know.
That’s an answer that should give all progressives a break. There is something very unprogressive about advocating a tax without knowing who is actually paying it.
An earlier generation of progressives understood this very well. Under the leadership of liberal economists like John Kenneth Galbraith, the Americans for Democratic Action (ADA) set the political agenda of the center-left for decades. Her early position on corporate income tax: abolish and tax shareholders on their share of corporate profits.
Of course, at the time, most shareholders paid income taxes. Today, stocks are often owned by companies (or financial institutions) that don’t pay income taxes – including IRAs, 410 (k) plans, pension funds, and nonprofits. Foreign stockholders pay dividend tax, but not U.S. capital gains tax. In fact, only 24 percent of shareholders are fully taxed today.
Some economists are forced to give their best guess as to who pays corporate tax because the nature of their job requires it. For example, the Tax Policy Center (a joint venture between the Urban Institute and the Brookings Institution) estimates that 20 percent of corporate tax is paid through work. The Congressional Budget Office (CBO) puts the burden on workers at 25 percent.
With the Tax Policy Center leaning to the left and the CBO being the counter for Congress, these estimates must be taken seriously. Joe Biden can say that raising the corporate tax rate from 21 percent to 28 percent will not result in a tax for anyone earning less than $ 400,000. But if members of Congress vote for the measure, they will be instructed by the CBO to vote to pull one in four dollars in increased government revenue out of the pockets of ordinary American workers.
As bad as that sounds, the reality could be a lot worse. It is possible that all of the corporate tax burden might fall on labor. How could that happen? Imagine that the return on investment (risk-adjusted) is determined on the international capital market. For example, suppose the United States imposes a tax on corporate profits based on equilibrium. As this lowers the return on capital invested in the US, the capital tends to flow out of our country to other countries where the return is now higher.
The most important factor that determines a country’s average wage is the amount of physical capital that is combined with it. As finance capital flows out of the country, there will be less physical capital than would otherwise be the case. (Firms will buy fewer factories, fewer machines, fewer structures, etc.) As financial capital becomes scarce, its returns will begin to increase and will continue to do so until it reaches the previous international average.
In the new equilibrium, the return on investment will be the same as it was before the tax. But since there is less physical capital than usual, wages will be lower than usual. In this way, the entire tax burden falls on labor.
What does the evidence show? The most sophisticated model of international capital flows ever developed was created by Boston University economist Laurence Kotlikoff and his colleagues. (Full disclosure: my own organization helped fund the development of the model.) The model took three years to develop and is constantly being updated. It has 3½ million equations. Multiple computers can take up to 6 hours to run for a single run.
Based on the results of the model, Laurence Kotlikoff and his colleagues published a groundbreaking study on the NBER Working Paper website in 2014. The study found that international capital flows are very sensitive to corporate taxation and wages are very sensitive to the amount of capital available. This realization applies not only to this country, but all over the world.
Based on the study, Kotlikoff wrote a column for the New York Times NYT arguing that the surest way to raise American workers’ wages is to abolish corporation tax. Alternatively, wages and family incomes can be safely reduced by taxing corporate profits.
If Kotlikoff and his colleagues are right, almost all of the revenue so far earmarked to fund Biden’s infrastructure spending will come from the pockets of people making less than $ 400,000 a year.