The Mysterious Incidence Of The Corporate Income Tax

Yesterday Mitt Romney offered the strange turn of phrase that “corporations are people” to try to express the point that when you increase the corporate income tax, the extra tax burden ultimate falls on human beings. The point is clearly true. If GE paid more taxes, some concrete people would have less money. But which people? The short answer is that nobody knows and the results seem wildly contingent on modeling assumptions.

A 2006 analysis by the Congressional Budget Office (PDF) in which “capital is assumed to be perfectly mobile internationally in the sense that the country in which a real investment is located does not matter to the marginal investor” concluded that “domestic labor bears slightly more than 70 percent of the burden of the corporate income tax” with domestic capital owners bearing the rest. By contrast, Jane Gravelle from the Congressional Research Service and Kent Smetters from Wharton found the exact reverse in their paper “Who Bears the Burden of the Corporate Tax in The Open Economy?”

This paper investigates the long-run incidence of the corporate income tax in an open-economy model calibrated with two economies: the United States and a larger mirror economy representing the rest of the world. Imperfect substitutability of domestic and foreign products plays a key role in limiting – often eliminating – the incidence borne by domestic labor. We reach two novel conclusions. First, contrary to conventional wisdom, our analysis reveals that most of the long-run incidence of the corporate income tax is not borne by domestic labor. Nor is much of it borne by landowners. This finding is usually true even at an implausibly large portfolio substitution elasticity. The incidence is typically borne by domestic capital, as in the original Harberger (1962) closed-economy model. Second, for those parameter values in which the incidence is not borne mostly by domestic capital, interestingly, most of the incidence is exported. The exportation of the incidence of the corporate income tax, which has received little or no attention in the previous literature, might motivate tax coordination between countries. These results are robust to a range of parameter values and model assumptions. Our model is also compatible with several empirical rigidities.

Long story short, state of the art research from two different arms of Congress has reached diametrically opposed conclusions. An informative Alan Auerbach paper (PDF) persuasively argues that there are many more issues to consider even than this, and muddies the waters even further. One of the main “real world” elements of the case for the corporate income tax, as I understand it, is that failure to impose such a tax would simply create an inviting method for evasion of individual income taxes.