Corporate Income Tax: Who Pays?
November 13, 2017 9:23 PM Subscribe
Whenever a discussion of taxation comes up, Republicans and especially big L libertarians claim that corporate taxes are always necessarily paid by the purchaser of the product and therefore the only rational corporate tax rate is zero. However, applying a bit of thought uncovers some seemingly obvious contradictions with other parts of their economic mental model. I'd like some help figuring out the real arguments on either side rather than the superficial crap that seems to dominate.
I see how at the most superficial level that it is true that if I sell you something and expect a certain rate of return I will pass through any tax I pay. Costs go up, so prices go up. However, these are usually people who also believe very strongly in free market pricing mechanisms. In the face of market forces, is it not equally possible that one or more competitors may choose to absorb the cost of the tax in the hopes of attracting more business with an effective price cut relative to competitors who do pass on the extra tax. Surely it can't be that simple, because it seems blindingly obvious that up to a certain point, so long as we have a functional market economy, much of any tax levied on corporations will be paid for with the seller's reduced profits or lower executive compensation (or at least slower growth in said compensation).
More importantly, has anyone ever collected and analyzed data specific to corporate taxes and how their costs are allocated between stakeholders in various industries?
Do people just look at telecom companies and the like, see what they are able to do with their oligopoly, passing through every tax and fee and often adding a markup for good measure, and assume that since it works that way for the giant near-monopolists that the same would be true even with a functional market? Is there any research that shows that either case is or is not true?
P.S. I'm not entirely sure this question will elicit great answers, but I do believe there is enough objective fact and hopefully even some relevant studies that people can point me towards. If anyone can clear up my confusion, I expect it is the fine community we have here.
Just for background, I was reading and watching some stuff about Friedmanites and other conservatives over the past 40 years or so that have advocated UBI or NIT instead of welfare and they always seem to veer off into the overall tax system and how we (supposedly) can't raise the money by taxing the wealthy and large corporations since we're effectively taxing ourselves. Absent tax evasion, that seems difficult to accept as such a hard and fast rule.
I see how at the most superficial level that it is true that if I sell you something and expect a certain rate of return I will pass through any tax I pay. Costs go up, so prices go up. However, these are usually people who also believe very strongly in free market pricing mechanisms. In the face of market forces, is it not equally possible that one or more competitors may choose to absorb the cost of the tax in the hopes of attracting more business with an effective price cut relative to competitors who do pass on the extra tax. Surely it can't be that simple, because it seems blindingly obvious that up to a certain point, so long as we have a functional market economy, much of any tax levied on corporations will be paid for with the seller's reduced profits or lower executive compensation (or at least slower growth in said compensation).
More importantly, has anyone ever collected and analyzed data specific to corporate taxes and how their costs are allocated between stakeholders in various industries?
Do people just look at telecom companies and the like, see what they are able to do with their oligopoly, passing through every tax and fee and often adding a markup for good measure, and assume that since it works that way for the giant near-monopolists that the same would be true even with a functional market? Is there any research that shows that either case is or is not true?
P.S. I'm not entirely sure this question will elicit great answers, but I do believe there is enough objective fact and hopefully even some relevant studies that people can point me towards. If anyone can clear up my confusion, I expect it is the fine community we have here.
Just for background, I was reading and watching some stuff about Friedmanites and other conservatives over the past 40 years or so that have advocated UBI or NIT instead of welfare and they always seem to veer off into the overall tax system and how we (supposedly) can't raise the money by taxing the wealthy and large corporations since we're effectively taxing ourselves. Absent tax evasion, that seems difficult to accept as such a hard and fast rule.
The microeconomics 101 concept would be "price elasticity", that is, how do supply and demand change as price does. An inelastic good is one where the amount demanded does not change much when the price increases. For such goods, most of the tax is paid by the consumer, since the producers will be able to simply add the tax to the price and sell the same amount. Contrarily, an elastic good is one where the amount demanded is very responsive to price, so most of the tax is paid by the producers either directly (by not raising the price) or in the form of lost sales. So alcoholic beverages might be highly elastic; if the booze costs too much, most people will drink something else. But staple foods would be inelastic as people will continue to buy them even if the price goes up. Gasoline is fairly inelastic, but it is much more so over the short term. If gas prices go up, you probably won't be able to significantly reduce your car travel. But if they stay high, you will look for ways to reduce trips or take the bus or be more fuel efficient.
Of course, this is all microecon 101 as I said, with all of the simplifications and distortions that go along with that. But it may give you a place to start.
posted by eruonna at 9:58 PM on November 13, 2017 [3 favorites]
Of course, this is all microecon 101 as I said, with all of the simplifications and distortions that go along with that. But it may give you a place to start.
posted by eruonna at 9:58 PM on November 13, 2017 [3 favorites]
I suppose you've seen this article? There are many like this out there with many citations attached.
posted by frumiousb at 9:58 PM on November 13, 2017 [1 favorite]
posted by frumiousb at 9:58 PM on November 13, 2017 [1 favorite]
I think the term you are looking for is "incidence" or "corporate tax incidence." There is a substantial economic literature on this, a few leading papers are described in this relatively evenhanded post from the New York Times a few years ago.
But, in a nutshell, if it is possible for a competitor to attract business away from its competitors with a price cut after the corporate tax, then it should be possible for the competitor to do the same thing even without the corporate tax. And then we would expect the competition to have already happened; the competitor wouldn't need the excuse of the corporate tax to start competing. So prices should now be in equilibrium. Or at least that is what I suspect your free market economists would say.
posted by willbaude at 9:59 PM on November 13, 2017 [1 favorite]
But, in a nutshell, if it is possible for a competitor to attract business away from its competitors with a price cut after the corporate tax, then it should be possible for the competitor to do the same thing even without the corporate tax. And then we would expect the competition to have already happened; the competitor wouldn't need the excuse of the corporate tax to start competing. So prices should now be in equilibrium. Or at least that is what I suspect your free market economists would say.
posted by willbaude at 9:59 PM on November 13, 2017 [1 favorite]
Would you agree that someone is paying the tax? Also, would you agree that in the absence of the tax, that is if it were to go away, prices of the goods could go down by the amount of the tax? Let's say in a free market that in the long run there might be corporations willing to break even or make a marginal profit. Let's say that the cost to make an item is $1.00. The corporate tax is $0.35. The profit this company needs is only $0.01. So the cost to the consumer is $1.36. Now, who is paying the tax? The consumer is. In the absence of the tax, that corporation would sell it for $1.01 so it is being passed through to the consumer in every case.
posted by AugustWest at 10:00 PM on November 13, 2017
posted by AugustWest at 10:00 PM on November 13, 2017
This is a micro-economics topic, summarized decently in Wikipedia, called Tax Incidence. Basically it says that a tax drives a wedge between the price the consumer pays and what the producer receives, and the burden of the tax falls upon either the producer or consumer based on their elasticity of supply and demand - in some circumstances the producer can pass the tax to the consumer, and in some cases they cannot.
posted by xdvesper at 10:03 PM on November 13, 2017 [4 favorites]
posted by xdvesper at 10:03 PM on November 13, 2017 [4 favorites]
Corporate income tax is on net profits: revenue minus expenses. The price elasticity arguments are therefore a little bit off base because the tax is not a certain amount per sale, but a percent of the profit, so if an item is profitable at a given price with no tax, it is profitable with hight taxes, albeit not as profitable. The article willbaude linked looks quite solid, and even leads with pointing out that corporate income tax is a tax on net profits.The general idea is that a corporate income tax will change what people invest in since it reduces the rate of return on investing in a corporation in the taxing country, making business opportunities in lower taxed countries or less taxed economic sectors more appealing for investment.
posted by Zalzidrax at 11:45 PM on November 13, 2017 [3 favorites]
posted by Zalzidrax at 11:45 PM on November 13, 2017 [3 favorites]
Republicans and especially big L libertarians claim that corporate taxes are always necessarily paid by the purchaser of the product and therefore the only rational corporate tax rate is zero.
This is the same crowd that takes the paper-napkin form of the Laffer Curve seriously. They're not worth arguing with in economic terms, because their objections to taxation are fundamentally ideological, not economic.
That said, the argument that higher corporate taxes necessarily translate to higher costs to consumers rests on two unstated and indefensible assumptions: first that the customers of the corporations concerned are always the general public rather than other corporations, and second that services provided to the general public by governments must necessarily cost more than if delivered by the private sector.
The relationship between Google, its advertising customers and the vast bulk of its users is a readily available counterexample to the first assumption, and the notably higher costs associated with healthcare in the US compared to any country with universal public healthcare are strong evidence against the second.
posted by flabdablet at 12:25 AM on November 14, 2017 [3 favorites]
This is the same crowd that takes the paper-napkin form of the Laffer Curve seriously. They're not worth arguing with in economic terms, because their objections to taxation are fundamentally ideological, not economic.
That said, the argument that higher corporate taxes necessarily translate to higher costs to consumers rests on two unstated and indefensible assumptions: first that the customers of the corporations concerned are always the general public rather than other corporations, and second that services provided to the general public by governments must necessarily cost more than if delivered by the private sector.
The relationship between Google, its advertising customers and the vast bulk of its users is a readily available counterexample to the first assumption, and the notably higher costs associated with healthcare in the US compared to any country with universal public healthcare are strong evidence against the second.
posted by flabdablet at 12:25 AM on November 14, 2017 [3 favorites]
The taxes could also be paid by reduced outflows to those extracting money from the corporations, be it salaries, dividends, etc. Customers aren't necessarily the ones to take the hit, but usually are.
posted by TheAdamist at 2:54 AM on November 14, 2017
posted by TheAdamist at 2:54 AM on November 14, 2017
One of the problems with the published literature on this topic is that much of it is focused on large corporations, and it ignores the taxes that are paid by those who receive money right after it leaves the corporate coffers.
The vast majority of businesses run in this country - corporations, LLCs, proprietorships, and partnerships - are "pass-through" entities in which there is no tax paid by the corporation or LLC at all, but the net profits of those businesses are fully taxed to their owners as ordinary income. This is a form of corporate tax - a tax on business activity - that is entirely invisible to many analysts.
For corporations (and the rare LLCs) that are taxed at their own level, there is a decided effort to keep "profits" down and thereby minimize the corporate tax paid. Expenses of the business are deducted and therefore not taxed. These days, this includes what is currently a pretty generous amount per year ($500,000) of what previously were regarded as "capital expenses" which had to be amortized via a depreciation deduction over a number of years. Now a new machine can be purchased and the entire cost, up to the annual amount, is directly deducted in the year it is put into service, and that money is not taxed to the corporation.
But when that expense is paid, it becomes part of the "gross income" of someone else, the person selling goods or services to the corporation, and that recipient will end up paying tax on what remains as "net income" after his expenses are deducted. So that money, to some extent, is taxed, just not "to the corporation."
Other than paying expenses and acquiring new equipment, corporations do three things with their money. They pay their employees, they retain the money, and they pay dividends to their shareholders. Payments made to the employees, including high pay to key employees, officers and owners who are employees, subject to some limits, are fully deductible to the corporation but become ordinary income in the hands of those employees. So that money is taxed, but not to the corporation.
What remains, what is typically characterized as "profits," is taxed to the corporation. Money that is retained is not paid out and does not represent an expense, but it remains available for business expansion, new hiring, etc. After the corporate tax is paid, that money is not taxed again until such time as it is used for some corporate purpose.
To the extent that dividends are paid to shareholders from what is left, those funds are also taxed to the recipients, though not as ordinary income. These funds are taxed at a lower rate, currently the same as the capital gains rate, precisely because they have been taxed once already.
posted by megatherium at 5:08 AM on November 14, 2017 [1 favorite]
The vast majority of businesses run in this country - corporations, LLCs, proprietorships, and partnerships - are "pass-through" entities in which there is no tax paid by the corporation or LLC at all, but the net profits of those businesses are fully taxed to their owners as ordinary income. This is a form of corporate tax - a tax on business activity - that is entirely invisible to many analysts.
For corporations (and the rare LLCs) that are taxed at their own level, there is a decided effort to keep "profits" down and thereby minimize the corporate tax paid. Expenses of the business are deducted and therefore not taxed. These days, this includes what is currently a pretty generous amount per year ($500,000) of what previously were regarded as "capital expenses" which had to be amortized via a depreciation deduction over a number of years. Now a new machine can be purchased and the entire cost, up to the annual amount, is directly deducted in the year it is put into service, and that money is not taxed to the corporation.
But when that expense is paid, it becomes part of the "gross income" of someone else, the person selling goods or services to the corporation, and that recipient will end up paying tax on what remains as "net income" after his expenses are deducted. So that money, to some extent, is taxed, just not "to the corporation."
Other than paying expenses and acquiring new equipment, corporations do three things with their money. They pay their employees, they retain the money, and they pay dividends to their shareholders. Payments made to the employees, including high pay to key employees, officers and owners who are employees, subject to some limits, are fully deductible to the corporation but become ordinary income in the hands of those employees. So that money is taxed, but not to the corporation.
What remains, what is typically characterized as "profits," is taxed to the corporation. Money that is retained is not paid out and does not represent an expense, but it remains available for business expansion, new hiring, etc. After the corporate tax is paid, that money is not taxed again until such time as it is used for some corporate purpose.
To the extent that dividends are paid to shareholders from what is left, those funds are also taxed to the recipients, though not as ordinary income. These funds are taxed at a lower rate, currently the same as the capital gains rate, precisely because they have been taxed once already.
posted by megatherium at 5:08 AM on November 14, 2017 [1 favorite]
Sometimes it helps to re-frame tax as something applied to a transaction, rather than considering it as a feature of a material good or service. megatherium gives lots of examples above.
posted by pipeski at 6:09 AM on November 14, 2017
posted by pipeski at 6:09 AM on November 14, 2017
High corporate taxes create and enable tax avoidance strategies while lower corporate taxes make tax avoidance far less attractive. This tends to level the playing field between corporations who focus on productive activity vs. those who prioritize financial structuring and associated rent seeking behaviors.
posted by Consult The Oracle at 6:47 AM on November 14, 2017 [1 favorite]
posted by Consult The Oracle at 6:47 AM on November 14, 2017 [1 favorite]
Response by poster: Thanks for the thoughtful answers. I've got some contrary thoughts on a few of them, but I'm fairly certain it would get too chatfiltery, so I'll digest the provided resources instead. ;) (And mark some best answers once I've had a chance to do that)
That said, further links/discussion on points that haven't been supported by sources (or on the non-obvious implications contained in those already linked) would be appreciated. The whole question is about the why, after all, and I don't want to get the wrong impression.
posted by wierdo at 7:26 AM on November 14, 2017
That said, further links/discussion on points that haven't been supported by sources (or on the non-obvious implications contained in those already linked) would be appreciated. The whole question is about the why, after all, and I don't want to get the wrong impression.
posted by wierdo at 7:26 AM on November 14, 2017
Distributing the Corporate Income Tax: Revised U.S. Treasury Methodology [PDF; US Treasury, Office of Tax Analysis, 2012]
Modeling The Distribution Of Taxes On Business Income [autodownloading pdf; Joint Committee on Taxation, 2013] - this one also discusses the difference between incidence of corporate tax on C corporation businesses and passthrough businesses
>how we (supposedly) can't raise the money by taxing the wealthy and large corporations since we're effectively taxing ourselves.
Taxing Ourselves: A Citizen's Guide to the Debate over Taxes, Slemrod & Bakija
I helped create the GOP tax myth. Trump is wrong: Tax cuts don’t equal growth. [Bruce Bartlett, Wapo]
What Is the Revenue-Maximizing Tax Rate? [Bruce Bartlett, Tax Analysts]
In summary, 82% of the corporate income tax burden is distributed to capital income and 18% is distributed to labor income.Would Workers Benefit From A Corporate Tax Cut? Not Much [Howard Gleckman, Tax Policy Center]
The Congressional Budget Office and the congressional Joint Committee on Taxation figure workers pay about 25 percent of the corporate tax through lower wages. In 2015, the career staff at Treasury calculated the worker share at 19 percent.. The Tax Policy Center uses a middle-ground assumption of 20 percent. JCT, CBO, and TPC used to assign the full value of the corporate tax to shareholders and lenders but have tempered that view in recent years.[...]How TPC Distributes the Corporate Income Tax [Jim Nunns, Tax Policy Center, 2012] (this is a longer paper that goes into how they got to the figures above; the bibliography may be of interest to you)
TPC calculates that the overall distribution of corporate taxes tilts heavily toward those with high-incomes. Middle-income taxpayers would receive less than 10 percent of the benefit of a corporate rate cut while the top 20 percent would receive about 70 percent. The top 1 percent would see about one-third of the benefits and the top 0.1 percent would get about one-fifth.
Modeling The Distribution Of Taxes On Business Income [autodownloading pdf; Joint Committee on Taxation, 2013] - this one also discusses the difference between incidence of corporate tax on C corporation businesses and passthrough businesses
>how we (supposedly) can't raise the money by taxing the wealthy and large corporations since we're effectively taxing ourselves.
Taxing Ourselves: A Citizen's Guide to the Debate over Taxes, Slemrod & Bakija
I helped create the GOP tax myth. Trump is wrong: Tax cuts don’t equal growth. [Bruce Bartlett, Wapo]
What Is the Revenue-Maximizing Tax Rate? [Bruce Bartlett, Tax Analysts]
At its core, the Laffer curve is unobjectionable. It shows simply that neither a 0 percent tax rate nor a 100 percent tax rate raises revenue; somewhere in between is a rate that maximizes revenue. The trick is to empirically estimate the revenue-maximizing rate based on the existing tax regime and economic conditions. It turns out that even supply-side economists have seldom found examples of tax rates that were so high that a rate cut would increase revenue.posted by melissasaurus at 8:41 AM on November 14, 2017 [5 favorites]
Let's say that the cost to make an item is $1.00. The corporate tax is $0.35. The profit this company needs is only $0.01. So the cost to the consumer is $1.36. Now, who is paying the tax? The consumer is. In the absence of the tax, that corporation would sell it for $1.01 so it is being passed through to the consumer in every case.
Just a short note that this is actually an example of a sales tax, not a corporate tax (which is on profits, so a fraction of the penny).
posted by mark k at 9:44 PM on November 14, 2017
Just a short note that this is actually an example of a sales tax, not a corporate tax (which is on profits, so a fraction of the penny).
posted by mark k at 9:44 PM on November 14, 2017
Let's say that the cost to make an item is $1.00. The corporate tax is $0.35. The profit this company needs is only $0.01. So the cost to the consumer is $1.36. Now, who is paying the tax? The consumer is. In the absence of the tax, that corporation would sell it for $1.01 so it is being passed through to the consumer in every case.
Just a short note that this is actually an example of a sales tax, not a corporate tax (which is on profits, so a fraction of the penny).
It doesn't sound like a sales tax at all. It describes a tax burden, of any kind, on a corporation. A sales tax is is a burden directly on the consumer, generally collected by the seller at time of sale, in addition to that tax burdens on the corporation that have already been tacked on to the wholesale price of the good. A sales tax is a percentage of the sale price, and may have almost no relation to the taxes that the corporation has to pay. Since the sale price also includes any retail markup, which may have no relation to the wholesale cost of the good.
posted by 2N2222 at 10:24 PM on November 14, 2017
In retrospect I was being sloppy. Fair enough point.
In context the Ask (and current political discussion) I still think an example of a 35% tax rate--which matches the current tax rate--that is levied against the gross cost instead of profit is a bad example. The basic rate is on the profit, so 0.35 cents in the original example.
A carbon tax or import duties might affect corporations the way the example says (though not typically at that scale.)
posted by mark k at 10:53 PM on November 14, 2017
In context the Ask (and current political discussion) I still think an example of a 35% tax rate--which matches the current tax rate--that is levied against the gross cost instead of profit is a bad example. The basic rate is on the profit, so 0.35 cents in the original example.
A carbon tax or import duties might affect corporations the way the example says (though not typically at that scale.)
posted by mark k at 10:53 PM on November 14, 2017
Let's say that the cost to make an item is $1.00. The corporate tax is $0.35. The profit this company needs is only $0.01. So the cost to the consumer is $1.36. Now, who is paying the tax? The consumer is. In the absence of the tax, that corporation would sell it for $1.01 so it is being passed through to the consumer in every case.
If the tax is levied on profits than in your example isn't the corporate tax rate set at 97.2% instead of 35%.
Costs = $1
Sell = $1.36
pretax profit = $0.36
tax = $0.35
posttax profit = $0.01
tax rate = 0.35/0.36 = 97.2%
Where did I go wrong?
Under the current 35% tax rate then the tax levied would be $0.126 giving a net profit of $0.234 per item. If the tax rate were to increase to 40% then the tax rate would only rise by $0.018 per item, so the hypothetical item would cost 0.02 more per $1 of cost to maintain the same profit margin.
posted by koolkat at 1:23 AM on November 15, 2017 [1 favorite]
This thread is closed to new comments.
posted by wierdo at 9:26 PM on November 13, 2017