The corporate tax on workers and consumers

One of the NDP's lines on the budget - the very first words spoken by Jack Layton in his reaction during the CBC coverage - is to denounce the continuation of the corporate tax rate reductions that began under Jean Chrétien's government in 2000. (The basic rate was 28% in 2000, is at 18% now and the plan is to go to 15% in 2012. The provinces have also been bringing down their rates.) Here are the introductory sentences from the NDP's corporate tax platform:

During elections, Liberals and Conservatives don't talk much about corporate tax cuts. But come budget time, the biggest priority for Liberals and Conservatives is another round of tax giveaways to Canada's wealthiest corporations.

Do you see something in there that doesn't make any sense in a discussion of corporate taxes? I'll get back to what it is later, but first I want to quote something from this delightful op-ed (h/t Tim Worstall) by Andrew Leigh, an economics professor at Australian National University. It's written for an Australian audience, but this part could run in a Canadian newspaper with only minor changes:

Promising to raise company taxes has an visceral appeal to any ambitious opposition. Perhaps some voters will think that they will be borne by the companies themselves, leaving all living persons miraculously unharmed. Slightly savvier citizens might think that company taxes are entirely borne by investors.

A central tenet of public finance, however, is that the entity that has the legal obligation to pay a tax is not necessarily the one that bears the burden. For example, payroll taxes are levied on firms, but we know that they are mostly borne by workers. Raise payroll taxes, and firms cut wages. Lower payroll taxes, and most firms will pass on a pay rise.

The GST is another case in which the burden of a tax doesn’t fall on the entity that pays the tax bill. Although the law says that the tax is levied on those who supply goods and services, it is customers who end up bearing most of the burden.

Which brings us to company taxes. For decades, economists have argued over how the burden of company taxes are shared between investors, employees and customers. In the short-term, it is difficult to change prices and wages, so a higher company tax rate will be paid in the first instance by shareholders.

But over time, the burden is likely to shift. Investors are a footloose bunch, with the ability to shift their money into sectors like real estate where they can avoid company taxes. For an open economy like Australia’s, higher corporate income taxes will lead investors to buy foreign shares instead (which is why small countries have been cutting company tax rates over recent decades). To keep their investors, companies may respond to the tax rise by raising revenue and cutting costs.

What will a company tax rise do to prices? While the evidence is thin, theory suggests that companies will be most likely to put up prices on consumers when they do not face competition from importers. So an Australian shoe manufacturer (do we have any left?) may be unable to shift the burden to consumers. But a fast food outlet will have greater capacity to raise prices.

In the case of wages, the empirical evidence is stronger. In a recent review of the literature, William Gentry (Williams College) concludes that most of the impact of a corporate income tax rise falls on workers. Increase company taxes by 10 percentage points, and wages fall by 6-10 percent.

I've made this point before (here, here and here), but not as well as this.

By now, it should be evident that the problematic phrasing in that quote from the NDP site is:

Canada's wealthiest corporations

Corporations can be big, they can be profitable, and they can be big and profitable. But they cannot be wealthy, for the simple reason that corporations are not people. Corporations are not wealthy; they are a form of wealth.

Comments

[Darren]

A further point.

Declan: "I guess some pundits or politicians might get confused and think that somehow taxes paid by a corporation are not paid by flesh and blood people at all, but that seems like such an elementary error it never really occurred to me that we might be taking it seriously as a risk in formulating public policy."

If pundits or politicians get confused by this, imagine the man in the street!

People who don't own a public economics textbook (that is, just about everybody), have probably never even heard the idea that "only people can pay taxes". I'm a trained economist and I did a double take when I first read that... I had to think long and hard about why that was so, philosophically speaking. (answer: ownership)

So, when people hear about "taxing wealthy corporations", they aren't quite sure who or what actually pays these taxes, but they're much more certain than they have any right to be that it's somebody or something that is "wealthy", and thus corporate income taxes are progressive.

If they hear about "taxing corporations", well, they know that not all corporations are doing so well, so maybe, just maybe, they will be more receptive to the true idea that corporate taxes are not just a costless way to stick it to the rich.

[Andrew F]

This is what I don't understand. If the idea is to stick it to the rich, why not do it directly with higher marginal rates rather than this round-about farce of taxing corporations (which is not even clear to be effective in taxing the rich owners and not the poor owners, workers, and customers).

[Just visiting from macleans]

Apart from the semantics argument, what's the case that the existing system of Corporate Income Tax is not working?