A new study provides a robust discussion of the economic incidence of business taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es, emphasizing that business tax burdens are allocated across consumers, workers, capital owners, and other actors in the economy. The study, by Anna Milanez of the Organisation for Economic Co-operation and Development (OECD), quantifies the amount of taxes businesses are legally obligated to pay and remit, which in the U.S. totals 93.1 percent of government tax collections, but stresses that others in the economy bear a substantial portion of that burden. The paper specifically discusses how the degree to which a tax burden can be shifted varies depending on the type of tax levied and on who is responsible for remitting the tax to the government, as well as other market factors.
Corporate Income TaxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
Economists generally agree that at least some share of corporate income tax costs are passed on to workers in the form of lower wages. Because corporate income taxes reduce returns on investment, firms have less incentive to invest and, in turn, demand less capital and labor. This reduced level of demand translates into lower returns for capital owners and for workers. The most robust studies reviewed by Milanez find a minimum 30 percent, and up to 70 percent, of the economic burden of the corporate income tax is shifted to labor in the form of lower wages.
Taxes on Wages
Businesses collect and send several taxes on wages to the government. These include withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es on wages, social security contributions, and other payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es, all generally considered to be borne entirely by workers through lower wages. Notably, evidence shows in some cases wages can be reduced by amounts larger than the tax being levied. For example, one study reviewed in the OECD working paper found that a 1 percent increase in payroll tax rates was associated in some instances with a wage reduction between 1.7 and 3.4 percent.
However, this point does not always hold for certain payroll taxes, such as those supporting unemployment insurance or workers compensation, because they may be partially shifted to consumers or capital owners instead of workers. One study that Milanez cited examined sector-level data and found negative impacts of general payroll taxes on wages, but small, positive wage effects in some sector-specific cases. Overall, the OECD working paper finds that workers bear the cost of taxes on labor income, though the costs are sometimes shared with others in the economy, and the level of sharing depends on the sector and the design of the tax.
Value-added and Retail Sales TaxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es
Most of the studies reviewed in the working paper reveal that consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. increases are fully passed on to consumers. But, in cases where firms have market power, evidence shows that they can over-shift tax burdens to consumers in amounts larger than the tax itself. For example, Milanez cites a study of cigarette prices in the United States, which found that a $1 increase in per-pack taxes amounted to a $1.074 increase in prices. The variation in tax burden depends on several factors, including market structure, time, location, and type of product, with most evidence indicating that consumers bear the full burden of consumption taxes.
Legal Remittance Responsibility
The question of how tax burdens vary with who is responsible for collecting and then sending tax revenue to the government has received little research attention because historically, economists have assumed remittance responsibility to be an irrelevant factor. Countering this once-accepted idea is new evidence that shows changes in who collects and remits a tax can affect economic incidence. A study of diesel fuel taxes in the United States has shown that reassigning who is responsible for legal remittance can enable a larger share of the cost of a tax to be shifted to consumers. As explained in the OECD working paper, reassigning remittance responsibility up the supply chain results in fewer businesses collecting and remitting the tax revenue, which makes tax evasion more difficult. In a competitive environment, the diesel fuel tax study finds that the “cost” of this reduced ability to evade tax will be passed on to consumers in the form of higher prices. Milanez emphasizes that more research should be pursued to better understand how different roles of business tax remitters affect tax burden allocation.
Together, these findings underscore that no analysis is complete by merely considering the immediate, legal incidence of a particular tax policy. A full analysis, rather, consists in following the consequences of a tax policy through the economy to determine how it will affect all groups. So, even though United States businesses pay, collect, and remit 93.1 percent of total government revenues, it is imperative to recognize it is others in the economy who bear a substantial portion of that tax burden. The studies reviewed in this new OECD working paper show that very rarely does the legal incidence of a tax match the economic incidence, but rather the burden of any tax is often shifted across workers, consumers, and capital owners.Share