Who bears the burden of a corporate tax?

JOE BIDEN wants to rebuild America, and he reckons that American firms can help foot the bill. Central to the president’s grand infrastructure-investment push is a plan to raise the tax rate on corporate income from 21% to 28% (though he has hinted he may settle for less). Although the administration pitches its tax proposals as a way to redress the problem that “those at the top are not doing their part”, opponents warn that corporate-tax rises do not simply fall on wealthy shareholders, but also shrink the pay packets of the working people the president claims to champion. In fact, workers often do bear some of the burden of increases in corporate taxes—though understanding just how much is a question that continues to vex economists. Nonetheless, the details of Mr Biden’s tax plans suggest that they may prove more worker-friendly than the usual effort to squeeze juice from Apple.

Other things being equal, a tax on corporate profits should hit shareholders—a group wealthier than the population as a whole—by shrinking the money available for dividend payments or reducing share values. But other things are never equal. Firms invariably respond to new taxes in order to minimise their costs. Depending on precisely how they seek to escape the tax, some of its burden may be passed on to others. A seminal paper published in 1962 by Arnold Harberger, an economist, reckoned that such wriggling by owners of capital was unlikely to shift the cost of a corporate tax onto other inputs to production. He imagined an economy with just two sectors, corporate and non-corporate, and then supposed that a tax was placed on the income of the former. Capital, he reasoned, should shift from the corporate sector to the non-corporate (consisting of partnerships and other sorts of business). As a consequence, the average rate of return on capital in non-corporate firms should fall, reflecting the flow of resources to lower-yielding sorts of production made attractive only because of the sector’s comparatively favourable tax status. Corporations could shift some of the burden of corporate tax to owners of capital in other parts of the economy, but not pass it on to workers.

Mr Harberger’s model made a number of simplifying assumptions, however. He assumed, for instance, that markets were perfectly competitive. In practice, firms may enjoy market power over either workers (in which case some of the cost of the tax may be absorbed by wages rather than just profits) or consumers (who may face higher prices). Perhaps most important, Mr Harberger assumed that the economy in question was closed. In practice, capital is relatively mobile across national borders—and intangible forms, like intellectual property, extremely so—while other factors of production like labour are not. Increasing corporate tax in one country might then encourage owners of capital to move activity abroad, diminishing the amount of capital per worker at home, and potentially reducing workers’ productivity and pay. Indeed, research by Laurence Kotlikoff of Boston University and Lawrence Summers of Harvard University showed that in very small, very open economies the burden of a rise in corporate-income tax could fall almost entirely on labour.

The size of an economy and its openness to capital flows are just two of the five factors that most influence an economic model’s conclusions regarding the incidence of corporate-tax changes, argued Jennifer Gravelle Stratton, then of the Congressional Budget Office, in a paper published in 2013. (Size matters because changes in the capital stock of larger economies have a greater influence on the worldwide return on capital.) Another factor is how seamlessly production may be moved abroad in response to tax changes. Similarly, the ease with which labour may be substituted for capital determines how badly workers’ economic prospects are affected when capital flees the country (or threatens to). Last, who pays most depends critically on how capital-intensive the corporate sector is: the greater the level of capital per worker, the more each worker suffers if a corporate-tax rise affects where firms choose to deploy their capital.

Sorting out the likely effects of a corporate-tax change, in other words, is complicated and messy. Empirical studies demonstrate exactly that. A paper published in 2015 by Kevin Hassett, later a chairman of President Donald Trump’s Council of Economic Advisers, and Aparna Mathur of the American Enterprise Institute, a think-tank, concluded that a 1% rise in the corporate-tax rate is associated with a 0.5% drop in wages: a result that implies that more than 100% of the burden of corporate tax lands on workers. At the other end of the scale, a study of economies in the OECD, a club of mostly rich countries, by Kimberly Clausing, an economist at Reed College who is now a deputy assistant secretary at America’s Treasury Department, found no clear relationship between corporate tax and wages.

Passing the buck

Other studies suggest the burden is shared. An analysis of the German economy published in 2017, which used variations in local business-tax rates to assess how their costs were distributed, concluded that more than half the burden is borne by workers. Economists who summarise the literature often note that labour bears some but not all of the burden of corporate tax—perhaps about 40%—while occasionally allowing that the true figure depends heavily on the context of a given tax measure.

Context, however, is subject to change. Reducing differences in corporate-tax rates across countries gives companies less scope to pass the tax burden on to workers by shifting production abroad. The Biden administration’s proposal for a global minimum rate is in large part targeted at firms that use accounting tricks to book profits in tax havens. Yet it should also deter governments’ efforts to lure production by undercutting other countries’ tax rates. That would ensure that more of the burden of corporate tax falls where it is meant to. ■

Explore our A to Z of economics