Who pays corporation tax?

Food for thought:

Who bears the corporate tax burden? Some may be tempted with a quick answer, "corporations." But that is clearly wrong. The Econ 101 admonition that people pay taxes -- in this case, suppliers of capital through lower returns, workers through lower wages, and/or consumers through higher prices -- remains true even when the tax is aimed at capital. And the category "owners of corporate capital" (that is, stockholders) is also too narrow. In his celebrated analysis of the corporate tax almost 50 years ago, Arnold Harberger showed, for a closed economy, that a separate tax on corporate capital would reduce returns to all owners of capital, making it a tax on saving (and, in a framework more general than Mr. Harberger's, on investment).

Recent research has cast an eye in a somewhat different direction, showing that the tax may be borne not entirely (or even principally) by owners of capital, but by workers. Globalization plays a role. In an open economy, with mobile capital, a source-based tax like the corporate tax will lead to a capital outflow, reducing investment and productivity and wages. Indeed, Mr. Harberger's updated research on the incidence of the corporate tax concluded that labor bears not just the brunt of the tax, but a burden that may be larger than the tax itself.

In other research assuming that the world-wide capital stock is fixed, William Randolph of the Congressional Budget Office finds that labor bears about 70% of the corporate tax. More generally, the burden on labor is higher to the extent that saving is responsive to after-tax returns and the country has a small effect on world prices of goods.

Most of this research has relied on theoretical models, albeit sometimes with parameters calibrated from actual experience. But direct empirical tests of the effects of openness, corporate taxes and their combination on workers' wages tell a similar story.

A recent paper by Kevin Hassett and Aparna Mathur of the American Enterprise Institute analyzes data across countries and over time, concluding that for countries that are part of the Organization for Economic Cooperation and Development (OECD), a 1% increase in corporate tax rates results in a 0.8% decrease in manufacturing wage rates.

Wage effects of this size suggest labor bears much of the burden of the corporate tax. In fact, workers collectively would be better off if they voted for higher taxes on labor with corresponding cuts in the corporate tax.

This is Glenn Hubbard at the WSJ (gated), via Assymetrical Information.

I almost always read the articles and papers I link to in their entirety, but I am not a subscriber to the WSJ and won't have time to go through the papers mentioned any time soon. (What's keeping me busy? There's something bothering me about the methodology of the recent paper on immigrants' institutionalisation rates I posted on here, and I also have some qualms about a paper on electrosensitivity that received quite a bit of coverage last week. I want to make sure I'm not missing something, and you will be reading about both soon.)

Having made clear I have not read Hubbard's piece or the quoted papers, I have a couple of comments:

1. Qualitatively, the analysis is sound. Tax incidence is a sneaky thing: labour is bound to be picking up part of the tab for corporation tax. This, of course, does not mean that they would necessarily like to see it cut: you raise a tax, you spend a tax, and you may like the latter part more than you dislike the former.

2. Quantitatively, the estimates seem excessive to me. In the face of uncertainty both Hubbard and the WSJ tend to argue well on the right of the mean, so - issues having to do with tax competition aside - I don't quite buy that 'workers collectively would be better off if they voted for higher taxes on labor with corresponding cuts in the corporate tax'. In the absence of more information, I will wait for Paul Krugman to rule on the matter - and then pick the mid-point.

Postscript: I said that the WSJ tends to argue on the right of the mean 'in the face of uncertainty', but of course sometimes they are outright fanatics.

by datacharmer | Monday, July 30, 2007
  | | Who pays corporation tax? @bluematterblogtwitter