The Facts About the Corporate Income Tax

Separating economic myths from economic truths.

Editor’s Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: We can collect more revenue by raising the tax rate on corporations or by increasing the top bracket.

Fact 1:  The wealth of the economy is a much better indicator of corporate tax revenue than tax rates and tax brackets.



This chart shows the corporate tax collection as a share of the economy side by side with the top marginal corporate rate since 1981. During that time, the U.S. corporate tax rate has been as high as 46 percent and has gone down to 34 percent. Since 1993, the top rate has been 35 percent. The level of income covered by the top tax bracket has varied a lot too: from $100,000 in 1981 to $1.4 million in 1984, down to $335,000 in 1987 and up again to $18 million since 1993 (all dollar amounts in nominal terms).

This chart makes clear that the general state of the economy is a much better indicator of the tax collection than rate levels and the top bracket. It is particularly visible since 1993, since the rate and top bracket haven’t changed and yet tax collection varied a great deal, falling during recessions and rising during recoveries.

Myth 2: Corporations pay the corporate income tax.

Fact 2: First, corporations do not pay taxes, only individuals pay taxes. More importantly, economists have shown that a majority of the corporate income tax is borne by labor mainly in the form of lower wages rather than borne by shareholders.

This chart (overly simplified for the Bloomberg discussion) is based on academic work done by Aparna Mathur and Kevin Hassett in December 2010 and shows the link between corporate tax rates and the average manufacturing wage (in U.S. dollars) for 65 countries between 1981 and 2005. It shows a negative link between tax rates and wages, suggesting that higher corporate tax rates lead to lower worker wages. Mathur and Hassett test this point by using regressions controlling for other factors. They find that a 1 percent increase in the corporate income tax leads to almost a 0.5-0.6 percent decrease in hourly wages.

Interestingly, a chart from their original 2006 paper shows that when the sample of countries is restricted to Organization for Economic Cooperation and Development (OECD) member countries, the negative slope is much more pronounced. That implies that higher corporate taxes have a stronger negative impact on wages in developed economies.

This is consistent with a growing body of work [see Arulampalam et al. (2007), Mihir A. Desai, C. Fritz Foley, and James R. Hines (2007), and Felix (2007)] that analyzes actual payroll data to see who in fact is bearing the corporate income tax. Such work finds a large impact of corporate income tax on labor—as high at 200 percent. The theoretical studies that followed found a lower but still large impact on wages from the corporate income tax. These studies show that from 45 to 75 percent of the cost of the corporate tax is borne by labor rather than shareholders, as has long been believed.

Here is the Congressional Budget Office’s William Randolph (2006) for instance:

Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Tim||

    "This video is private"

  • Fist of Etiquette||

    Awwwww yeaahhhhhhhhhh.

  • Fist of Etiquette||

    The public video up now isn't as seksy as I imagine the private one was.

  • Max||

    Swallow, Veronique, swallow.

  • Pip||

    Tips from the master.

  • Barry||

    There's a goooood cracker, Max.

  • ||

    There's something extraordinarily telling in that the U.S. tax rate for corporations is the highest among the OECD nations.

  • Confederal_Republic||

    Yeah, and I even know what it is - a colossally oversized and tyrannical network of federal/state/local government. HOLY FUCK. REVELATION. HOLD THE FUCKING PRESSES.

    I'm just leaving this here for Tony and Max. Just attaching it to your comment for effect.

  • DLM||

    I've seen several times someone claiming corporate taxes are merely passed along to the consumer. However, this never quite made sense to me. I tend to think the price a consumer is willing to pay is governed primarily by supplly and demand. Just because costs to a business increase, does not mean it would be able to increase prices and pass along that cost increase to consumers. It *would* mean businesses at the edge just barely making a profit and who could not increase revenue would be forced to decrease cost some other way (if not go out of business entirely). Decreased wages for labor (among other things) as a result of inreased taxes (or other costs) makes much more sense. I suppose it would partly depend on the type of business as to exactly what or who would be most affected.

  • Highway||

    Businesses that want to stay in business price their services such that their revenues will cover their costs. Taxes are one of the costs that businesses incur. So it makes sense that if taxes on businesses are raised, a significant portion of that will be required to come from revenues, so the revenues need to increase to cover the taxes. How do you increase revenues? Raise the prices.

    Why would businesses that already make pretty thin profits (10% of revenue, most of which then goes to other things to further develop the business) just eat increased costs that might exceed the available money they have to spend it. They're going to raise prices instead.

  • DLM||

    How do you increase revenues? Raise the prices.

    Which works great if you are a monopoly and don't have to worry about the competition. Of course services/products must be priced to cover costs. That doesn't mean people will pay it. (Just thinking 'out loud'.) However, if the competition, assuming there is any, also incurs the same costs then prices would seem likely to increase. Hopefully, from the business' perspective, the price was already set at the optimal level to maximize profit. If people choose to buy less because of these increased prices, this could still reduce profits driving out businesses on the edge of profitability. Keep ratcheting up corporate taxes (business costs), then there would certainly end up being being a single monopolistic business in that industry. Depends on how far it's taken.

  • Jim||

    Businesses that want to stay in business price their services such that their revenues will cover their costs.

    Businesses that want to stay in business will also not raise their prices above what consumers will bear, regardless of their tax burden. Prices are not set by cost inputs; prices are set solely by what consumers are willing to pay.

    For a rough example, I can buy the most expensive lemons I can find, hand-squeeze them for hours, and try to sell a few jugs of lemonade for a lot more than it costs at the local grocery store. I'm simply trying to recover my costs (material input + time), however, if not enough people will purchase it, then I go out of business. Alternatively, a wealthy person with nothing but money & time on their hands could conceivably sell some product at far below what it cost to produce, eating the difference.

    Asking prices may often be set by cost inputs, but the asking price has nothing to do with the actual price (the point at which sufficient consumers are willing to purchase your product in order for you to stay in business).

  • jacob||

    +100

  • cynical||

    It would pass it to someone.

    It can pass it to shareholders, at the risk of shareholder suits, replacement of upper management, and decreased capacity to attract capital.

    It can pass it to labor, at the risk of lower morale, layoffs, or losing access to higher quality employees.

    It can pass it to consumers, at the risk of consumers rejecting the price increase.

    The first is least likely (since the decision makers are most at risk), but wages are stickier than prices, so unless unessential personnel can be trimmed or benefit decreases can sneak through invisibly, consumers are likely to bear the brunt -- but if they reject the price increases, the company simply fails.

  • Sam||

    Or it could pass it to upper management... JUST KIDDING, of course that would never happen.

  • Dave T.||

    In a perfectly competitive market, all of the cost will be passed to the consumer because Supply = Marginal Cost. Corporate taxes are part of the marginal cost. If the demand curve doesn't happen to intersect with the Marginal Cost/Supply Curve above the AVC curve, then the industry disappears completely.

    In non-perfectly competitive/monopolistic markets, the cost is probably split.

  • ||

    And yet GE paid $0. I am sure there are others. Please. In reality, these corporations all duck the 35% rate and most pay less than 20% after you factor out the rediculous tax code of rebates for big business. Can you seriously write this article and only give a passing nod to this reality?

  • DLM||

    And yet GE paid $0. I am sure there are others.

    Yes. You really need to look at NET taxes. I wonder how many deductions and credits are solely to benefit specific businesses. There are certainly some that benefit specific industries.

  • uhh||

    You realize in the GE case that's due to "green" subsidies, right? Maybe you should take that up with Dem. President who appointed a former GE CEO to a top economic position. Hurr durr durr....

  • ||

    "Fact 2: First, corporations do not pay taxes, only individuals pay taxes. More importantly, economists have shown that a majority of the corporate income tax is borne by labor mainly in the form of lower wages rather than borne by shareholders."

    I must be dense, but I'm having a hard time understanding how both "corporations don't pay taxes" and "corporate income taxes lower labor wages" can both be true.

  • Cicero||

    The (individual) laborers are (indirectly) paying the tax.

  • Fist of Etiquette||

    People should use a qualifier like "effectively" when stating that corporations don't pay income tax.

  • ||

    Well if that's the case, it's still misleading as she goes on to point out that labor shoulders 45% to 75% of the corporate tax burden. So corporations do pay taxes, it's just that workers are adversely affected by a reduction in wages.

  • Cicero||

    The other 65%-25% is passed on to costumers, or paid by shareholders in the form of lower dividends.

    http://www.nationalreview.com/.....frey-miron

  • The Gobbler||

    "I've seen several times someone claiming corporate taxes are merely passed along to the consumer. However, this never quite made sense to me."

    Let me help you with that:

    Corporate taxes are merely passed along to the consumer.

    True story. Corporations set earnings targets, which are conveyed to Wall Street and must be achieved. If corporate taxes rise, a company can only do a few things to correct this. Cut O&M, raise prices or employ creative accounting techniques.

    Cutting O&M has drawbacks and creative accounting techniques are really only a short-term patch. The only long-term solution is to raise prices. Moreover, if corporate taxes go up, it impacts all businesses, so there is little chance of losing market share to your competitors due to raising the price of your products because they are taking the tax hit as well.

  • A secret message from Michelle||

    Veronica De Rubgy rocks!

  • ||

    To simplify:

    A corporation will cover its tax expense one of two ways (and probably some of each):

    (1) Raising prices to consumers.

    (2) Cutting expenses. The biggest expense for most corporations? Their workforce.

    Thus, the tax gets "passed on" to either consumers, workers, or both. The corporation winds up about where it would be without taxes, but consumers and workers are a little poorer.

    But by God the class warriors can pat themselves on the back for sticking to The Man! Woohoo!

  • ||

    I'm of the opinion that corporations shouldn't be taxed at all, but the shares held should be. On both increases in share value and dividends.

  • DLM||

    I'm of the opinion that corporations shouldn't be taxed at all, but the shares held should be.

    I can't think of a good reason to tax corporations, except that some people are able to use corporate assets for personal benefit, which would then not be taxed. Still, I tend think this is not a big deal on balance.

  • unPC||

    Let me help. There is a *very* good reason for the government to threaten corporations with a whopping 35" corporate tax.

    The reason is that corporations respond to the threat by buying off incumbent politicians with campaign contributions etc.

    de Rugy's article mentions, if only in passing, that tax credits and exemptions result in an effective tax rate much lower than the nominal rate of 35%. That is the case because corporations play the game that the politicians force them to play.

    No one should condemn GE for avoiding corporate taxes. They are just playing the game by the rules the politicians have imposed.

    The system works beautifully, if you are an incumbent politician. There's no downside to it.

  • ||

    I know most here would probably advocate no corporate income tax, but I have to say I think we could see some benefit from a little (major) change. I like the idea of significantly lowering the corporate income tax but also completely eliminating associated deductions, credits, and subsidies. Meaning ALL corporations would pay SOMETHING. Not some paying a lot and others paying nothing because some crook in Congress is trying to protect a business in his district or one that finances his campaign.

    Here in Michigan, I think our governor is doing something similar, at least as far as eliminating deductions and credits.

    Of course, this would never happen since lobbyists run our country, but a guy can dream, right?

  • Tony||

    So since the effective corporate tax rate is lower than average, that means we are business friendly, n'est-ce pas?

  • uhh||

    Citation needed.

  • Tony||

    This article.

  • BigT||

    We are friendly to those co's that have friends in DC and clever tax depts. A flat tax on Revenues (1.5%) would end the corrupting shenanigans that GE et al get away with, and free up many accountants and lawyers for gainful work.

  • Tony, simplified||

    Corporations are evil. Tax them highly, as they deserve no mercy.

  • General Electric||

    *cough*

  • uhh||

    Well, no. She does claim that the US "effective" rate is lower than the top rate. She does not provide information on the "effective" rates of those other OECD countries. The US is not the only country with a system of subsidies, tax breaks/rebates, and untaxed capital movement. I know that the EU especially, with one of their guiding philosophies being free movement of capital, has a whole hodgepodge of "effective" corporate tax rates.

  • ||

    I'm of the opinion that corporations shouldn't be taxed at all, but the shares held should be. On both increases in share value and dividends.

    You should be happy then. Dividends are taxed, and so are shares (when the increase in value is realized in an actual transaction).

    If you really want to screw the government during downturns, try taxing shares on their value annually regardless of when they are sold.

    When the market dumps, all those shares in the toilet are going to generate deductions which will kill government collections.

    Not to mention, in boom markets, all those vapor gains will push revenues sky-high, which will of course lock in sky-high spending.

    One thing we don't need, is volatile tax revenue. The worst of both worlds.

  • STIGLITZ ALERT||

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  • Samuel L. Jackson||

  • ||

    You know a good way to combat passing costs onto consumers? Government price controls.

  • Replica||

    Here in Michigan, I think our governor is doing something similar, at least as far as eliminating deductions and credits.

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  • ||

    The effective tax rate for corporations within the U.S. is 20%. This is TAXES PAID and very equalizing among all OECD countries. The US Govt should enact a law making 20% the rule. Monies earned overseas receive a tax credit when paid into other countries (afterall the sales theoretically occur in those same countries).

    THE BIGGER PROBLEM THAT IS CONTINUOUSLY OVERLOOKED BY ACADEMICS, MEDIA AND WALL STREET IS THIS:

    1. Corporations are paying their EXECUTIVES FAR TOO MUCH MONEY. And by executives, I mean anyone in a Director, VP, SVP and higher levels.
    2. Corporations are paying their executives FAR TOO MUCH MONEY in comparison to the peanuts they pay their employees. The skew gap is tremendous- 60 to 1, and worse. I mention this TWICE because it is so Overlooked!
    3. Corporations ARE EFFECTIVELY STEALING FROM YOUR RETIREMENT. If you have a 401k or an investment fund in any equities, you are missing out on TONS OF MONEY. Why? Because corporations can EASILY be more profitable and it's not by enacting a round of layoffs among middle management. Companies can pay out MUCH MORE in dividends by paying their executives (and the HR department) on a compressed scale in comparison to employees. This DELeveraging would bring more money to the bottom line.
    4. Large corporations regularly have 15%-20% of their expenses coming from salaries. AND THIS DOES NOT INCLUDE other hidden cash expenses that are tough to read in the SEC filings, which includes things like tax 'gross ups', aka, companies paying ALL of the taxes for top executives.

    POPPING THE BLOATED SALARY/BONUS COMPENSATION FOR EXECUTIVES COULD IMMEDIATELY BOOST COMPANY PROFITS TREMENDOUSLY. IT WOULD ALSO GIVE THE AVERAGE 401K INVESTORS SOME REAL MONEY TO SOCK AWAY.

    At the moment, YOUR MONEY is instead going to fund lifestyles of a few executives.

  • Sanjay||

    Very nice thought provoking article on Corporate tax . The style of writing as Myth Buster is superb.

  • sologn||

    is good

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