Why progressives should support reducing corporate tax rates

A recent working paper, entitled "The Incidence of Corporate Income Tax on Wages" (26-page pdf) by UBC's Mick Devereux an entirely different Michael Devereux (thanks to Martin Boileau's correction in the comments) and a couple of colleagues at Oxford's Centre for Business Taxation, provides even more evidence to believe that the traditional aversion to corporate tax cuts among progressives is misguided. Here is the conclusion:

Simple models of a small open economy yield strong results for the optimal taxation of capital located in that country. Given a world rate of return, a tax will raise the pre-tax rate of return, but leave the post-tax rate of return unaffected. The rise in the pre-tax rate of return is achieved by an outflow of capital which reduces labour productivity and hence the compensation received by the immobile domestic labour force. Although these effects may be moderated as the size of the economy rises, there is nevertheless a presumption that the burden of the tax will be shifted away from the owners of capital to the labour force.

We test this proposition directly using a large database of 23,000 companies in 10 countries over the period 1993 to 2003. We allow for the effects described above, and also consider the impact of taxes in a rent sharing framework where the workforce bargains with the company over the allocation of location-specific rent.

The results strongly support the hypothesis that source-based taxes on corporate income are passed on in the form of lower wages. We find sizable effects using two alternative models. The more moderate effects, found in both Model 1 and Model 2, suggest that just over half of an increase in tax liability would be passed on to the workforce in the short run. In the longer run, the fall in employee compensation would exceed the original increase in the tax liability. The effects found in Model 2 are even larger. There is also some evidence that for multinational companies, higher effective tax rates in other parts of the multinational group tend to have a positive effect on domestic wages.

Given that tax liabilities are highly positively correlated with profit, and the wage rate is positively correlated with profit, the unconditional correlation between the wage rate and the tax liability per employee in the data is strongly positive. To identify the effects of tax on the wage rate it is therefore necessary to control adequately for other effects on wages, particularly through profit and productivity. This makes the large negative effects of taxation found here even more striking.

Emphasis added. Corporate taxes are not a progressive measure.

See also:

Corporate profits are not driving the increase in the top-fractile income shares. So how would higher corporate taxes reduce inequality?

Who pays corporate taxes?

Comments

[reason]

Stephen,
I happen to agree with you on this (as on much else). But you have a lot of convincing to do! Particularly in the US, conventional wisdom is hard to shake no matter how much hard evidence you collect. The only way you'll get anywhere is to get Paul Krugmann to give you support.

[Martin Boileau]

Stephen:

I fear you have the wrong Devereux (although both are outstanding economists).

Michael B. Devereux is at UBC:
http://www.econ.ubc.ca/devereux/mdevereux.htm

Michael P. Devereux is at Oxford:
http://www.oriel.ox.ac.uk/content/224

[Stephen Gordon]

Huh. I thought it was somewhat atypical of his work, but it's not as if Mick hasn't given much thought to the workings of international capital markets and their implications for policy. Thanks for the correction.