Incidence

I hate the corporate income tax.  I hate it for a number of reasons, which I hope to post here over the next week or two.

The first reason I hate the tax is because it is hard to determine who, in the end, pays the tax. Economists call the distribution of the burden of a tax its incidence. Economists prefer taxes with a clear burden; public policy objectives can be inadvertently distorted if the distribution of a tax is not well understood.  The incidence is not necessarily apparent. Many economists believe, for instance, that the division of the payroll tax into an employee and an employer share doesn’t accomplish its end–of putting half the burden on the employer.  The employer doesn’t calculate his pay offer based on the base number. He or she calculates total compensation, including benefits and the payroll tax, and makes the pay offer accordingly.

In comparison, the corporate income tax represents a nightmarish problem of determining incidence.  The tax is aimed at the shareholders of the corporation, but depending on the price elasticities in both the product and the labor markets, the tax may be shifted to either workers or consumers.  The corporation’s goal is maximizing after tax profits.  Doing so may involve both evading/avoiding the tax, and attempting to shift the burden onto either consumers of their products (through price increases) or their employees (through wage cuts).

If a product is highly price inelastic–that is, if consumers are not sensitive to price increases–and the industry concentrated, tacit pricing agreements shift the burden of the tax to consumers. Tobacco is an obvious example. Likewise, if labor markets are slack, the corporate income tax burden can be shifted onto workers, in the form of lower wages or reduced benefits.

If the intention is to tax capital holders, then it makes sense to use a tax that does so more directly.  For instance, a stock transaction tax would be very difficult to shift onto any group other than stockholders.

In the end, though, Mitt Romney was right. Corporations may not actually be people, but in the end, corporations don’t pay taxes, people pay taxes. The trouble with the corporate income tax is that it’s hard to figure out who those people are.

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