Monday, August 22, 2011

A quick comment on corporate tax incidence

Lee Sheppard has an article in today's Tax Notes that riffs off Mitt Romney's "corporations are people" comment last week to address corporate tax incidence.

Lee criticizes economic models suggesting that labor bears the main burden of the corporate tax, in part by stating:

"It has even become fashionable to say that labor bears something like 40 to 80 percent of the economic burden of the corporate income tax. This defies common sense. We know that because if labor bore such a significant share of the corporate income tax, corporate managers would not devote so much time and effort to fighting it."

Here's why I believe Lee is wrong about this. The incidence claims are about the long-term difference between equilibria. For example, suppose a country raises its corporate tax rate, within a couple of years this reduces the amount of capital that would otherwise have been invested in the country, and this in turn causes wages to be lower than they would otherwise have been. Proof of the causation in this sequence would demonstrate that labor was bearing some of the corporate tax increase via the wage effect.

In politics, however, people mainly care about short-term transition effects. Thus, suppose that today (without any prior anticipation of this happening) we simply repealed the corporate tax. Ignoring the deficit problems that this would cause, along with the rampant avoidance of the individual income tax that it would empower, who would be the big transition winners? Obviously, shareholders at the moment that the change occurred (or rather was announced) would get a huge increase in share value from eliminating all company-level income tax liability. Managers no doubt would win big-time as well. Meanwhile, wages for the most part would not change immediately.

This not only explains the observable political alignment on corporate tax issues, but is entirely consistent or reconcilable with the long-term incidence story that focuses on labor and wages.

Lee also complains in her article about a recent vote by the American Economic Association not to require disclosure of funding sources. She believes that private funding has undermined the objectivity of research, along with intellectual balance in the corporate and international tax fields. Treading carefully here, as I am on friendly terms both with her and with some of the people whom she might conceivably have in mind, let me just say that I agree this is a serious problem, which cannot be dismissed simply by defending people's good faith and/or incentive to preserve their own intellectual reputations. What is more, from conversations I have had with a variety of people, I can definitively say that many in the field share Lee's concern, including people who do academic research and/or are not fully on her side in the underlying debates.


Paul said...

I have a question about corporate tax rates. If taxes are on profits and investments subtract from profits why wouldn't an increase in tax rates not lead to more investment to avoid taxes?

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