The Incidence Of Corporate Income Taxes: Much Debated, Little Understood

In his March 2024 State of the Union, President Biden unveiled new proposals to reverse this rate and bring the headline rate to 28 per cent,[2] similar to what President Obama had proposed as part of his framework for business tax reform.[3] In the international arena, the OECD Base Erosion and Profit Shifting (BEPS) Project has also pushed for higher levels of corporate taxation on multinational corporations, and discussion on this new framework has been ongoing for more than a decade.[4] Within the US, there is much debate about whether the impact on US companies and US revenues justifies US involvement in the project, as evidenced by a recent hearing in Congress.[5]

Implicit in these efforts to change business taxation are ideological differences and varying beliefs about the economic impacts of high corporate tax rates. Do high rates primarily hit the rich, and should we therefore force businesses to pay their ‘fair share’? Or do high rates hurt everyone - and the economy - by impacting business investment and profitability? The reality is that the incidence of the corporate income tax itself is a subject of much debate. Who really bears the burden of the corporate income tax in a setting where capital and labour are globally mobile? We are only now starting to understand.

Preceding the TCJA corporate rate cut and the arrival of President Trump in the White House, there was general agreement among policymakers that the US system of corporate taxation was ripe for reform. At 35 per cent, the US rate was one of the highest in the OECD countries.[6] It was widely accepted that high rates distort investment decisions and are not beneficial for countries. Intense tax competition among European economies to attract companies resulted in what the OECD called the “race to the bottom.” This is also why the OECD’s Base Erosion and Profit Shifting Project attempts to impose a global minimum tax across countries so that competition does not lead to low levels of corporate taxation and threaten the fiscal balance.

Theoretical research on corporate tax incidence dates back to economist Arnold Harberger, who in 1962 and again in 1995, provided estimates of the incidence of the corporate tax on capital owners and labour in a closed economy and open economy setting, respectively. While in closed economy settings, the entire incidence is borne by capital owners, in an open economy setting, the results switch as workers, being the less mobile factor, may bear two to two and half times as large as corporate tax revenue. In 2006, economist William Randolph of the Congressional Budget Office showed that under certain assumptions, labour can bear more than 70 per cent of the tax burden.[7]

In 2006, Kevin Hassett and I co-authored the very first empirical research paper (first reviewed in The Economist in 2006, published in 2015) that studied the incidence of the corporate income tax on workers. We looked specifically at workers in manufacturing, and compiled cross-country evidence on worker wages and headline, effective average and marginal tax rates for 65 counties. Our study showed that high corporate tax rates were negatively associated with worker wages. A series of other papers that subsequently studied the topic found similarly significant, and large, impacts.

Using data on European companies, Arulampalam, Devereux and Maffini (2012) find that a one dollar increase in the corporate tax reduces the wage bill by 49 cents.[8]  Desai, Foley and Hines (2007) find that 45 to 75 per cent of the incidence is borne by workers.[9]  Peichl, Sieglos, Fuest (2017),  using a 20-year panel of German municipalities, confirm the view that labour bears a substantial share of the corporate tax burden.[10]  Dwenger et al (2019), also using German data, produce similar results while holding employment constant, but note that when changes in employment are accounted for, the wage bill only falls by 19 to 28 per cent of the tax increase.[11]

Azemar and Hubbard (2015) study incidence in 13 OECD countries, and find that 60 per cent of the overall (direct and indirect) corporate tax burden is shifted to labour on average.[12]  While there is some skepticism about the size of these effects, empirical papers in general find a large incidence of the corporate income tax on workers.[13][14] Government agencies, such as the Joint Committee on Taxation and the Treasury, assume a share of 20 to 25 per cent on labour when estimating the distributional impacts of corporate tax changes.

The mechanism by which higher rates impact workers can be two-fold. One, as documented in the literature and in my own research, is the role of corporate tax rates on physical capital investment. For instance, Djankov et al (2010) use data on effective corporate income tax rates in 85 countries. The data comes from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on "the same" standardised mid-size domestic firm. Estimates suggest a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 per cent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by two percentage points.[15] Eric Ohrn (2018) finds that higher effective corporate tax rates reduce investment.[16] An overview by the OECD finds similar negative effects of high rates of taxation on capital investment.[17]

Given this research, it is interesting to question whether the very significant reduction in corporate rates following TCJA resulted in higher investment and wages. A few studies document these impacts. A March 2024 paper finds that the reduction in the corporate tax rate and the full expensing of investment lead to an increase of 20 per cent in domestic investment for firms benefitting from the tax change.[18] Another study finds that relative to Canadian firms, US firms increased capital investment post-TCJA.[19]

With regards to worker wages, a 2023 research paper by Patrick Kennedy finds that the reduction in marginal tax rates as a result of the TCJA increased the earnings of the top 10 per cent of workers in the earnings distribution, as well as executives.[20] Accounting for the fact that many workers own equity, about 20 per cent of the corporate tax cut gain goes to workers in the bottom 90 per cent of the wage distribution. An extension of this research suggests that these effects were more concentrated amongst workers with longer tenures, men, and older workers.[21] The authors suggest a range of reasons for this. Perhaps certain employees are better able to respond to increases in hours required as businesses benefit from rate reductions, have higher productivity, and are better able to negotiate increases in pay.

How do these lessons impact other ongoing and proposed tax reforms? A recent analysis of the OECD Base Erosion and Profit Shifting project suggests that there could be potentially significant investment impacts as a result of both Pillar One and Pillar Two.[22] Amount A Pillar One creates new taxing rights (while pushing for the removal of unilateral measures such as digital services taxes), and a reallocation of residual profits towards market jurisdictions. Pillar Two creates a global minimum tax that companies will need to pay irrespective of where they are headquartered or where they earn their profits. This particular proposal would lead to higher taxation on companies currently headquartered in low tax jurisdictions and could lead to a relocation or reduction in investment in these jurisdictions.

A recent analysis from the Joint Committee on Taxation suggests that the US could potentially lose $1.4 billion from the new taxing framework under Pillar One.[23] Effectively this means that US companies will be paying more in corporate taxes outside the US. But who will actually bear the incidence of this tax? How will this impact economic activity, and how will companies respond to these new forms of taxation? As I have written in my previous article, these are good empirical questions with unfortunately no good answers.

[1] https://tax.kenaninstitute.unc.edu/what-do-we-know-about-the-effects-of-the-tax-cuts-and-jobs-act/overview-of-the-tcja-effects-tracker/

[2] https://www.usatoday.com/story/news/politics/2024/03/07/president-biden-to-propose-corporate-tax-hikes-at-state-of-the-union/72878064007/

[3] https://obamawhitehouse.archives.gov/issues/taxes

[4] https://www.oecd.org/tax/beps/about/

[5] https://taxnews.ey.com/news/2024-0549-ways-and-means-subpanel-holds-oecd-pillar-one-hearing#:~:text=The%20March%207%20House%20Ways,billion%2C%20based%20on%20one%20set

[6] https://taxfoundation.org/research/all/federal/benefits-of-a-corporate-tax-cut/

[7] https://www.cbo.gov/publication/18067

[8] https://www.sciencedirect.com/science/article/abs/pii/S0014292112000451

[9] http://www.piketty.pse.ens.fr/files/Desaietal2007.pdf

[10] https://cepr.org/voxeu/columns/incidence-corporate-taxation-and-its-implications-tax-progressivity

[11] https://onlinelibrary.wiley.com/doi/abs/10.1111/geer.12157

[12] https://onlinelibrary.wiley.com/doi/abs/10.1111/caje.12179

[13] https://crsreports.congress.gov/product/pdf/IF/IF10742

[14] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2212959

[15] https://www.nber.org/system/files/working_papers/w13756/w13756.pdf

[16] https://www.aeaweb.org/articles?id=10.1257/pol.20150378

[17] https://one.oecd.org/document/ECO/WKP(2023)18/en/pdf

[18] https://deliverypdf.ssrn.com/delivery.php?ID=108065093065092092001125070078030067032037017041086025023085013065083081064102013030057099100122006004105118091002000072123067116038000015045103086107067093087120007016053064116115075101077009126087068123107064007108107110072118092065118102099088096&EXT=pdf&INDEX=TRUE

[19] https://deliverypdf.ssrn.com/delivery.php?ID=586024090004110070090110030118112105036053067045062087091090094119012065085096092104033016012031048048013086086026108082115017009094094009064089089016124094115068033035060102107120119081096125078006091095017084067022071002008121081029007002108026098&EXT=pdf&INDEX=TRUE

[20] https://patrick-kennedy.github.io/files/TCJA_KDLM_2023.pdf

[21] file:///C:/Users/apmathur/Downloads/HeterogeneityInCorporateTaxIncidence_preview%20(1).pdf

[22] https://www.oecd-ilibrary.org/sites/23ce5d0f-en/index.html?itemId=/content/component/2

[23] https://www.jct.gov/publications/2024/jcx-7-24/

[24] https://www.ifcreview.com/articles/2024/january/decoding-pillar-one-amount-a-some-insights-and-a-qa-with-chatgpt/

Aparna Mathur
Aparna Mathur is a former Senior Fellow at Harvard Kennedy School’s Mossavar-Rahmani Center for Business and Government where she is researching the US social safety net. She is a Visiting Fellow at FREOPP and a Senior Research Manager in Economics at Amazon. Aparna spent a year as a Senior Economist at the Council of Economic Advisers during the pandemic. She joined the Council as part of the COVID-19 response task force at the peak of the crisis in April 2020 and worked with epidemiologists on the health aspects of the crisis, while also tracking the economic downturn that came with the lockdowns. Prior to joining CEA, she was a resident scholar in economic policy studies at the American Enterprise Institute. At AEI, she directed the AEI-Brookings Project on Paid Family and Medical Leave, building bipartisan momentum on paid leave, for which she was recognized in the Politico 50 list for 2017. Her academic research has focused on income inequality and mobility, tax policy, labor markets and small businesses. She has published in several top scholarly journals including the Journal of Public Economics, the National Tax Journal and the Journal of Health Economics, testified several times before Congress and published numerous articles in the popular press on issues of policy relevance. Her work has been cited in leading news magazines such as the Economist, the New York Times, the Wall Street Journal and the Washington Post. She has regularly provided commentary on prominent radio and television shows such as NPR’s Marketplace and the Diane Rehm Show, as well as CNBC and C-SPAN. She has been an adjunct professor at Georgetown University’s McCourt School of Public Policy. She received her Ph.D. in economics from the University of Maryland, College Park in 2005, and is currently serving on the University of Maryland Economics Leadership Council. She is also on the Board of the National Academy of Social Insurance, Simply Green and the National Economists Club.