September 29, 2017
Who Pays the Corporate Tax?
Among the issues surrounding tax reform is who bears the
noncorporate). It could slightly exceed 100% or slightly fall
burden of the corporate tax. The burden could fall on
short, but was always close to 100%.
stockholders, on capital owners in general, or on labor. This
question is important for characterizing the distributional
Economists then began applying the model to an open
effects of the tax. If the tax reduces the returns to capital, it
economy in which the tax could cause the capital stock to
falls largely on higher-income individuals who own
contract because capital could flow out to other countries.
relatively more of capital assets and is progressive (i.e., the
An important advantage of a model is that it can set the
tax rises as a share of income as income rises). If it reduces
limits of what might be expected. The first, simplest,
wages, it falls on workers and it is less likely to be
models suggested that significant taxes could fall on labor.
progressive.
In the case of a small open economy with one good and
A considerable amount of economic research has appeared,
with perfect capital mobility (i.e., investment flows to the
especially in the past 10 or 15 years, examining the
highest rate of return regardless of location) and where
incidence of the tax. That research is reviewed in detail in
foreign and domestic products are perfect substitutes, the
CRS Report RL34229, Corporate Tax Reform: Issues for
full burden of the tax falls on labor income. Capital flows
Congress, by Jane G. Gravelle. That review suggests that
out of the country to the rest of the world causing the pre-
the evidence supports most or all of the burden falling on
tax return to rise and because prices must remain fixed (due
capital.
to perfect product substitution) and capital owners must
earn their original after-tax return, only the wage rate
Sometimes claims are made that the tax falls on the
adjusts, falling enough to offset the rise in the pre-tax
corporation’s customers (and by implication on purchases
return.
in the economy). Only relative and not absolute prices
matter in determining burden and aggregate real prices
These are strict assumptions; as they are relaxed, the burden
cannot rise in the economy due to taxes. A corporate tax
is more likely to shift to capital. For example, applying the
would raise the prices of corporate goods but at the same
model to a larger economy causes part of the burden to fall
time lower the price of noncorporate goods, with the overall
on capital.
effect on prices zero. Therefore, economic research has
focused on which factor of production (labor or capital)
Empirical evidence also suggests that capital is not
bears the burden, which is the more important issue for
perfectly mobile (i.e., investing abroad is not a perfect
distributional issues.
substitute for investing at home). Relaxing that assumption
causes a larger share to fall on capital as capital cannot
This research reflects two different approaches to empirical
move as easily. Similarly, making foreign products
estimates of the burden: embedding behavioral responses in
imperfect substitutes for domestic products makes the
a general equilibrium model and reduced-form statistical
economy less open and, again, causes more of the burden to
estimates.
fall on capital. Overall, using values from the empirical
literature for the three major behavioral effects (how easily
Behavioral Responses in a General
substitutable capital is across jurisdictions, how easily
Equilibrium Model
substitutable foreign products are for domestic ones, and
how easily capital can be substituted for labor in
Since the 1960s, the standard approach to studying the
production), as well as how capital intensive the corporate-
corporate tax burden was through a general equilibrium
tradable sector is compared with the economy as a whole,
model. The model that prevailed for many years was one
labor appears to bear between 20% and 40% of the burden;
with a closed economy with a fixed capital stock. This
hence, the majority falls on capital.
model shows that the burden falls on capital. The corporate
tax causes the return in the corporate sector to fall, and
This analysis likely still places too much of the burden on
capital moves out of that sector and into the noncorporate
labor for several reasons. First, some share of the profit that
sector. The contraction of the capital stock in the corporate
generates taxes is in the form of rents with the burden borne
sector causes the rate of return before tax to rise, restoring
entirely by stockholders. Although little evidence is
some of the original after-tax return, whereas the abundance
available on the share of rent, that evidence suggests a share
in the noncorporate sector causes the rate of return to fall,
of 10% to 20%. This share suggests a range of 15% to 36%
spreading the burden to other capital income. It also causes
falling on labor.
prices to rise in the corporate sector and fall in the
noncorporate sector. With a reasonable set of empirical
Strictly speaking, the analysis applies only to a source-
assumptions, wages were largely unaffected and the burden
based (territorial) tax in which the U.S. corporate tax
fell around 100% on capital (both corporate and
applies only to profits earned in the United States. The U.S.
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Who Pays the Corporate Tax?
system is a worldwide system, but defers tax on dividends
corporate taxes and thus they appeal to an even smaller
of foreign subsidiaries and allows a credit for foreign taxes.
variable. Second, it is difficult to determine whether these
As a result, there is only a small residual tax (of about 5%)
results would apply to the U.S. corporate tax.
on foreign source income. This tax should reduce the share
falling on labor slightly.
There is also a body of studies, mostly prepared by
European economists, that examine the share of rents that
Finally, and most importantly, the corporate tax subsidizes
labor receives using a bargaining framework. These studies
debt, so lowering the corporate tax will bring in more
are often cited as evidence of the U.S. corporate tax burden.
equity capital but less debt. As estimated in a study of this
This effect may be relevant in countries where unions are
phenomenon, if debt is more substitutable across countries
strong, such as the UK and Germany, but unions in the
than equity, lowering the corporate tax would cause a
United States are much less important and have declined
contraction of total capital and a fall in wages. The
over time; less than 7% of workers in the private sector are
consideration of debt could reverse the findings, indicating
unionized. Most of these studies suffer from the same
that labor income falls when the corporate tax is reduced.
problems as the cross-country and cross-state studies, and
most find implausible effects, particularly as they should
Another issue to consider is whether other countries might
capture only the share of rents which, themselves, are a
react to the United States lowering its tax rate, by lowering
small share of profit. Ironically, the economic theory they
their own rates. Many countries lowered their tax rates
use to model and justify their regressions actually indicates
following the reduction in the U.S. corporate tax rate from
that while before tax profits would be shared in a
48% to 34% in 1986. If other countries respond, those
bargaining situation, the tax itself would not be. Thus, these
changes will reduce the burden on labor that arises from
studies face a strong burden of proof when they seek an
equity flows.
effect contradicted by theory.
Reduced-Form Statistical Estimates
Recent news reports indicated that the U.S. Department of
Treasury has referenced studies indicating that the
Over the years, numerous studies have appeared that try to
corporate tax falls mainly on workers, initially citing a
estimate the effect on wages by statistical regression
study that found 60% of the burden falling on workers. The
techniques in which the change in wages (across countries,
study cited was actually of the kind just discussed,
or in some cases across states) is estimated based on a
estimating the share of rents and not likely relevant to the
number of explanatory variables, including the corporate
United States. It also produced implausible results given
tax rate.
that rent is likely a small share of profits. The Treasury has
offered three additional citations. One was to a general
Such estimates face many difficulties, among them that
equilibrium model that used perfect substitutability of
using a small variable, corporate taxes, that is about 2% of
capital and products and estimated 70% of the burden fell
GDP, to explain labor income, which is about two-thirds of
on capital. That paper, however, clearly states that the
GDP, is unlikely to be robust (i.e., estimates are sensitive to
effects would be smaller if these assumptions were relaxed.
small changes in variables). In addition, many of these
One was to a cross-country study that yielded implausible
studies have yielded implausible results. For example, one
results, and the third fell into the group of studies
cross-country study’s estimates indicated that labor income
examining rent and likely not relevant to the United States.
falls by $22 for each $1 of tax, an outcome that is
theoretically impossible, as shown in the previous
Current Practices
discussion. The authors later revised their estimates and
found smaller results, but they still implied a fall in labor
Currently, the Congressional Budget Office and the Joint
income of $13 for each $1 of tax. Most of these studies,
Committee on Taxation assign 25% of the burden of the
when examined closely, have errors, rely on restrictive
corporate tax to labor when preparing distributional results.
assumptions, or have results that disappear with reasonable
The Department of Treasury had a similar assignment in
changes in specification.
previous studies.
Studies across states have two additional limitations when
Jane G. Gravelle, Senior Specialist in Economic Policy
used to infer U.S. corporate tax incidence. First, the state
corporate taxes are themselves only a fraction of federal
IF10742
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Who Pays the Corporate Tax?
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