Monday, April 13, 2015

Who Bears the Burden of the Income Tax on Corporations?


Who Bears the Burden of the Corporate Income Tax?

No other question in the arena of public finance is as controversial as “who bears the burden of the corporate income tax.  Economists who specialize in public finance simply don’t know.  So, if you encounter an economist who says he does know, you will know you have found an economist who says more than he knows!

The first fact to get on the table right at the beginning is that only people pay taxes.  Corporations remit taxes, of course, based on income that they earn (a.k.a., net income or profits), but that does not mean that corporations (which are not persons) bear the burden of taxation of corporate income.  By now in this course, we are familiar with the difference between tax incidence and tax liability. 

Whoever it is that bears the burden of taxation of corporate income, those persons will get to spend (or save) less each year than they otherwise would, if the United States did not tax income earned (a.k.a., earnings or profits) by businesses registered with the IRS as C corps.   Only persons from three broad categories could possibly bear the burden.  They are (1) shareholders of a corporation (owners of the corporation), (2) owners of the factors of production (land, labor, and capital), which the corporation pays to use, (3) persons who buy goods or services from the corporation (consumers).  Consequently, I am absolutely certain that I do not bear any burden of the income tax paid by GM, since I am not a shareholder, I do not sell GM factor services that I own, and I do not buy GM products. 

Students of public finance will recall that people who have few options to avoid a taxed activity (such as earning income or buying cigarettes or buying insulin) will end up bearing all or part of the burden of any tax, regardless of who actually has legal liability to collect and remit the tax.   Economists say that such persons have “inelastic” demand (or supply) curves for the activity.  Perfectly inelastic demand or supply curves result in complete bearing of the burden of a taxed activity in which one engages.  

So, if I must work to live, and if the politicians tax wage income, then I will bear nearly all the burden of a tax on my wages.  On the other hand, if I am independently wealthy, and the politicians tax wage income, I can avoid bearing part of the burden of a tax on wage income by reducing the hours I work for pay, up to and including not working for wages at all!

I am really confident that shareholders bear the immediate burden of a new or a raised tax on corporate income in the economic short run.  They do so because the corporation will remit money to the government that would otherwise have gone directly to shareholders equity (retained earnings) or would otherwise have been paid directly to the shareholders as dividends.  Following the imposition of a new or a raised tax, corporations will not have time to raise the price of their products to shift the tax forward to consumers, nor will they be able to shift the tax backward to employees by reducing their wages and salaries, nor will they be able to shift the tax backward to owners of land they are renting by negotiating a lower rent, nor will they be able to reduce what they are paying for any other factor of production.

But in the economic long run (after people make all the adjustments to a new tax they care to make), I think that consumers of goods and services sold by corporations bear most of the burden of taxation of corporate earnings.  I cannot be sure, though, because the lived world does not allow economic researchers to conduct an experiment that can appropriately hold everything else constant while we impose a new tax and measure everyone’s income before and after the new tax, after an appropriate amount of time has passed to allow everyone to make all the adjustments they care to make.

 But we can be sure that given enough time, shareholders (who are supplying capital to finance activities of corporations) will reduce the quantity of money (capital) they supply, if the rate of return to holding shares of corporations is lower than the rate of return such savers (a.k.a., investors) can earn through some other activity.  Alternatives to holding shares of stock in a corporation abound.  One can buy gold, paintings by Monet, farm land in the Midwest, corporate bonds, silent partnerships in non-corporate forms of business, etc.  Investors (a.k.a., savers) do not have to buy shares of stock in  C corporations in the United States.  Capital always flows to the highest bidder (of equal risk), given enough time, just like water seeks the lowest level.  So, owners of capital have options for avoiding the corporate income tax.  It’s hard to imagine how shareholders will end up bearing the burden in the economic long run.

What about employees of corporations?  Can owners of a corporation (shareholders) push the burden of the corporate income tax backward to its employees, by reducing their pay (or by withholding future raises as inflation occurs)?  Or, can employees just work somewhere else, should owners of the corporation try to shift the tax?  Do employees have options to avoid the backward pushing? 

At this point, I want to point something out.  Shareholders do not meet somewhere and vote whether or not to try to shift the income tax levied against their corporation.  Moreover, employees have no way of knowing whether their wages and salaries are not rising fast enough to avoid getting some of the burden pushed back to them.  The very language that economists use to talk about shifting tax incidence is actually a little silly, since any tax shifting that occurs is completely hidden from view and takes an unknown amount of time to occur, if it does occur.

What about consumers who purchase the products of corporations?  In the economic long run, can corporations simply raise their prices to shift the burden of their income tax forward to consumers?  I think that corporations can and do just that.  After all, businesses must be able to recover all the costs of production, plus a competitive profit to compensate owners of the business, in the economic long run.  Businesses that cannot cover all the costs of production will quit producing, in the economic long run.

From the point of view of a business owner, paying taxes is just like paying the electric bill.  Taxes can be thought of as a slip of paper that says “you paid your taxes,” which slip of paper is required to produce and sell, and which is just another cost of doing business.  Consequently, I think that in the economic long run, prices of goods and services produced by corporations adjust upward to include the complete burden of the corporate income tax, thereby shifting the burden of the tax to people who buy those products. 

But, I will conclude by repeating that I cannot know for sure, nor can any other economist.         

Saturday, April 11, 2015

Redistributing Income

As you may have noticed, one of the two major political parties in the United States is all about redistributing income.  According to supporters of that particular political party, the distribution of income that results before redistribution is not equal enough and is not fair.  Consequently, much of the legislation supported by this political party is designed to take income away from Peter (who evidently has more income than would be fair) and give it to Paul (who evidently has less income than would be fair).

Members of this political party also complain that the top 1% of income earners in the United States earn way, way too much more than 1% of total income, and the lowest 20% of income earners earn way, way too much less than 20%.  Some people agree with the claims of this political party; some people do not. 

The word "fair" has no clear, settled meaning.  Yet, we all use the word as if we all know exactly what it means.  In my judgment, the word "fair" cannot be used in any logical way in talking about the distribution of income. 

Some people say that "fair" means "equal."  But it's hard to see how equal income for engineers and restaurant servers could be thought fair by anyone.  Moreover, I've never met anyone who thought engineers and restaurant servers should earn equal income.  Some people say that "fair" means "deserved."  Perhaps, but if so, what will we want to say "deserved" means?  Does Tiger Woods deserve his enormous income, just because he possesses athletic abilities particularly suited to hitting golf balls into small holes?  Does Bill Gates deserve his enormous income, just because his mind is so structured that DOS made sense to him for a computer operating system?  Don't we all "deserve" prosperity?

The distribution of income in the United States is unequal because the capabilities of people are unequal and because all people do not want the same goods and services.  Equal income cannot and will not come about in a society of people who have different capabilities and who have different wants. 

Attempts to redistribute income in the United States, which have been ongoing on a major scale since the "War on Poverty" initiated by President Lyndon Johnson in the early 1970s, have scarcely changed the real distribution of income in the United States.  Today, through a variety of transfer payment programs, government transfers about $1 trillion per year from someone who earned the income to someone who did not.  The simple truth is that if somehow overnight, income were distributed exactly equally among the nation's 125 million households, within just a few weeks, income would once again be distributed unequally.  Until people all have the same capabilities and the same economic wants, the distribution of income will remain unequal.

Human prosperity is not the same thing as the distribution of income.  As an observable matter of fact, human prosperity around the world has been rising dramatically over the past 250 years. Perhaps people would benefit by focusing more on the causes of human prosperity and less on the distribution of income.  But try telling that to the political party that favors redistribution of income.

P.S.  I am personally not a member of a political party.  I am not a partisan, so please don't disparage my simple observation of obvious truth for political argument.