Corporate tax incidence: some evidence

Here are three papers which show that taxes that formally fall upon companies in fact cost workers money.
1. Bill Gentry concludes from a literature survey (pdf) that “labor bears a substantial burden from the corporate income tax.”
2. Work by Alison Felix in the US finds that: 

Labor bears a substantial weight of the corporate tax. While this burden has fluctuated over time, the relationship between corporate taxes and wages has been consistently negative. In other words, higher corporate taxes are typically associated with lower wages.

3. A study of European countries finds that, in the long-run, 92% of any rise in corporation tax falls upon wages.
This, I think, corroborates the view that employers’ NICs are in fact paid at least in part by workers: why should these be significantly different from corporation tax?
A big part of the mechanism here is the wage bargain. It‘s well-established that higher (pdf) profits lead to higher wages. This might be because of efficiency wage considerations; firms fear that if workers feel that they are being ripped off by high profits and low wages, they will shirk, so they pay more to motivate staff. Or it might be because more powerful workers threaten to quit if they don’t get a share of firms’ better fortunes. As a result, if firms get a tax break, workers will share in it. And conversely, if firms face a tax rise, workers will share the pain.
I don’t say all this to make a partisan political point; as I say higher employer NICs don‘t raise wage costs only because they lower wages - a point which hardly supports Labour's policy. I say it merely to emphasise the importance of the idea of tax incidence - that taxes don’t necessarily fall upon the people that they are formally levied upon. An inability to grasp this point is one of the features that distinguishes economists from non-economists.

Comments

[Mark Wadsworth]

Sure, economic tax incidence is different to legal incidence.

You are probably right to say that employees bear the vast bulk of National Insurance (whether employees' or employer's) and I'm prepared to go along with the idea that corporation tax or VAT is also largely borne by employees, but there is an equal and opposite argument to say that as employees work for their NET wages, taxes on employment must be borne partly or largely by employers.

Be that as it may, the right-wingers like to say that as employees bear the bulk of corporation tax, corporation tax should be scrapped - this would lead to all sorts of distortions and evasion.

Far better to have a flat tax on all sources of income, whether employee or sole trader or partner or corporate and have done with it.

Even better, is to accept that 'all taxes come out of rents' (whether in the literal sense of ground rent, actual or notional, or in a wider sense out of any state-protected monopoly right, like charished number plates or radio spectrum) and tax rents instead of production.

[Tim Worstall]

"A big part of the mechanism here is the wage bargain. "

Well, mebbe. As far as I'm aware (and of course this isn't all that far) the mechanism is more about the greater mobility of capital.

1) Average wages are set by the average productivity of labour within an economy.

2) There is a level of risk adjusted normal profit globally.

3) Capital is more mobile than labour.

Thus a rise in the taxation of returns to capital (ie, corporation tax) will lower the return to capital in that economy below the global risk adjusted average. This will lead to, at the very least, new captial investments being made in other economies. Thus the amount of capital being added to labour falls over time and productivity is lower than it would have been without the tax. Thus wages are lower.

Now of course capital isn't perfectly mobile (not least Smith's thing about the merchant preferring domestic employment of it), there isn't absolutely a global risk adjusted normal return and so on. But certainly Mike Deveraux (the co-author of one of those papers) has used this model as his explanation, as has the CBO and I think Gentry mentions it too.

[chris]

@Tim - the mobility of capital bears directly upon the wage bargain. It's the credible threat to leave that helps employers force wages down, relative to what would otherwise be the case.