Source: Investor’s Business Daily
My daydream is to lock all members of Congress and the president in a classroom with a big whiteboard and not let them out until they can pass a basic test in public finance. The first thing I’d teach them about is tax incidence — who really bears the burden of a tax.
Our politicians seem to think the burden of taxes falls on those who they require to pay, as in remit or transmit or hand over or submit or mail in, the tax. This is entirely off base. Who bears the burden of (is hurt by) a tax has nothing to do with who physically delivers the payment to the government or how it’s delivered.
Suppose, for example, apples are selling for $1.00 each and the government passes a law requiring apple producers to pay a 10-cent tax on each apple they sell. Also suppose that the folks buying apples are very keen on continuing to buy as many apples as they did before, even if it means paying $1.10 per apple.
In this case, the apple tax will result in a market price of $1.10 per apple, leaving the sellers netting $1.00 ($1.10 less 10 cents) per apple.
Yes, the sellers will collect the tax and deliver it to the tax authorities. But because they receive, on net, the same amount per apple, they are no worse off. The buyers, in contrast, are worse off, since they end up buying the same number of apples, but at the higher price.
So a tax that the government says and thinks is falling entirely on apple sellers ends up falling entirely on apple demanders — i.e., buyers.
Our politicians never publicly discuss tax incidence, so one must presume that they have little or no understanding of this critical issue. This is terribly unfortunate when it comes to considering the corporate income tax.
Corporations are owned by shareholders, and shareholders are richer, on average, than other people. So the politicians conclude that in taxing corporations (as in making corporations remit the tax payments) they are actually taxing rich people, as in making rich people worse off. Moreover, they have the public convinced this is the case.
But there is every reason to expect a very different incidence of the tax. Shareholders can and do direct their corporations, over time, to relocate more, if not all, of their operations outside of the U.S. in response to lower foreign corporate tax rates.
In so doing, they not only avoid paying the U.S. corporate income tax. They also leave American workers behind. With fewer companies bidding for their services, workers end up working at lower pay, assuming they can find work. So American workers, not rich American shareholders, get hurt.
The U.S. now has one of the highest marginal effective corporate income-tax rates of any developed country in the world. But it collects only 1.8% of GDP in corporate tax revenue.
There are several reasons the tax haul is so small. But a big one is the decision of American and foreign companies to operate in more tax-friendly places. This includes, by the way, operating abroad and deferring the repatriation, for U.S. corporation tax purposes, of foreign profits.
If the corporate taxes being collected generate only 1.8% of GDP in revenue, does this mean that the maximum damage to U.S. workers is only 1.8% of GDP? No, as this simple thought experiment makes clear:
Suppose Uncle Sam raised the corporate tax rate to 100%. In this case, no corporations would operate in the U.S., and most U.S. workers would lose their entire livelihoods. This could represent a 50% loss in GDP. The loss to U.S. workers would be a gain to foreign workers, who would face more demand for their services. This is why that whiteboard is important.
There are cases, like that involving the corporate income tax, where one party can bear a massive tax burden and another party benefit by an equally massive amount, but the government collects no revenue.
OK, but is the U.S. corporate income tax primarily a hidden tax on American workers?
Answering that question requires putting together an elaborate, multicountry computer simulation model. And doing so honestly requires not making implausible, politically motivated modeling assumptions, but rather incorporating assumptions that the vast majority of economists would view as reasonable.
I’ve developed such a model with two German colleagues — Hans Fehr and Sabine Jokisch. Our study shows remarkably large benefits to U.S. workers of completely eliminating the corporate income tax and raising personal income tax rates to make up any loss in revenue.
The model produces a huge and quite rapid inflow of capital, raising the United States’ capital stock (machines and buildings) by 23%, output by 8% and the real wages of unskilled and skilled workers by 12%.
The model, like all economic models, is highly abstract. So I wouldn’t bet the entire farm on its precise findings. But the qualitative and quantitative results certainly make economic sense.
The results also echo Ireland’s tremendous growth experience when it dramatically cut its corporate income tax rate. In 1987, Ireland began cutting its 50% corporate tax rate to 12.5% — the rate reached in 2003. As a consequence, the country experienced a massive inflow of capital, with over 1,000 multinationals setting up shop.
The extra investment drove growth. Indeed, between 1987 and 2007 Ireland’s GDP growth rate averaged 6.4% per year compared with 3.7% per year between 1971 and 1987.
Of course, the U.S. is a much bigger fish than Ireland, and its elimination of the corporate income tax might lead other countries to follow suit. But as the study shows, U.S. workers still come out ahead even in this case because the playing field with respect to producing in the U.S. becomes level, whereas now it’s tilted away from U.S.-based production.
So why not eliminate the corporate income tax? The answer our politicians would provide, even after passing their public finance test, is that doing so will be perceived as a giveaway to the rich, even if it’s actually a benefit to workers, many of whom are poor.
My response is to reposition the corporate income tax and do so in the context of an overall tax reform called the Common Sense Tax.
This revenue-neutral reform eliminates our current payroll tax and replaces it with a tax on all labor income at a 13% rate. And it replaces the personal income tax with a tax on all income of married couples above $100,000 ($50,000 in the case of single households).
By all income I mean all income, including the income shareholders earn annually via their corporations. So shareholders would be treated just like small-business owners and be forced to pay taxes, at the individual level, on their corporate income as they earned it.
Repositioning the corporate income tax in this way, so that it’s paid at the personal level on corporate profits no matter where they are earned, leaves shareholders directly paying taxes on this income and corporations having no incentive to locate anywhere but the U.S.
This is a win-win for Democrats and Republicans, but primarily for American workers.
• Kotlikoff is a William Warren Professor of Economics at Boston University and Director of the Tax Analysis Center.