Who Bears the Burden of the Corporate Income Tax?

August 25, 2006

A new report released Thursday by the Congressional Budget Office (CBO) estimated that for the corporate income tax in an open economy like the United States, workers could bear as high as 70 percent of the tax burden, while owners of capital would bear around 30 percent. Here is part of the abstract from the report:

Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners. To the extent that capital is less mobile internationally, domestic labor’s burden would be lower and domestic capital’s burden would be higher. Burdens can also be affected by the domestic country’s ability to influence the world prices of some traded corporate outputs. But the signs and magnitudes of those effects on burden depend upon the relative capital intensities of production in the corporate sectors that produce internationally tradable goods.

Currently, many estimates of the consequences of changes in corporate income tax policy make a drastically different assumption regarding the economic incidence (who really bears the burden) of corporate income taxes. For example, in its distributional work, CBO, the Urban-Brookings Tax Policy Center, and formerly Treasury assume(d) that the entire burden falls on capital owners. See TPC documentation. That is, these types of estimates typically assume that a larger fraction of the burden falls on the owners of capital, and a much lower burden falls on workers than what is estimated in this piece. Some other works (like some that have been done in the past at the Tax Foundation) also assume in some cases that consumers bear some burden of the tax.

So what could these new numbers mean? First, these numbers could imply different revenue estimates for given changes in tax policy than were conducted previously when they assumed different relative sensitivities to the corporate income tax for capital owners, consumers, and laborers.

Second, these estimates imply that distributional estimates of the true economic burden of the corporate income tax would tend to overstate the tax burden on capital owners, which are more likely to be upper income earners. It would also then understate the tax burden of laborers, whose incomes are less likely to be skewed towards the wealthy than capital income. This would also imply that those tax models that do distributional analysis of proposed tax changes would be overstating the benefit to the wealthy that would come from lowering the corporate income tax, and understating the benefit to middle class income earners.

Finally, the fact that the tax burden could fall so highly on labor makes one question the purpose of a progressive rate structure on corporate income taxes. It is almost indefensible when you consider that labor is bearing a very large fraction of the economic incidence of the tax. Why should Business A that has a profit of $50 million pay a higher tax rate than Business B with a profit of $1 million when the laborers of Business A and Business B are bearing so much of the burden? The laborers in Business A don’t even necessarily earn higher incomes than the laborers in Business B and in fact could be paid less than the workers for Business B, yet are subject to higher taxation through this progressivity of the corporate income tax.

For more on this topic, Greg Mankiw had some comments on this report on his blog.

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