Would cutting the U.S. corporate income tax boost wages significantly?

In a column for the The Wall Street Journal earlier this week, economists Kevin Hassett and Aparna Mathur of the American Enterprise Institute offered a solution to wage stagnation in the United States: a cut to the U.S. corporate income tax rate. The crux of the argument made by Hassett and Mathur is that the incidence of the corporate income tax falls mostly on labor (employees) and less on capital (shareholders). But that’s not necessarily the view of many other studies on the subject. It’s not clear how much of a boost in wages most workers could get from a cut in the corporate rate.

Hassett and Mathur argue that the more the incidence of the corporate income tax falls on labor, the more of a boost in wages workers would get from a tax cut. They point to their own research as well as other studies showing that, despite its intentions, the corporate income tax gets paid by workers. Other economists disagree. Reed College’s Kimberly A. Clausing, in a 2012 paper, raises some questions about several studies finding that the incidence falls mostly on workers, noting that the theoretical work in the area has “failed to reach a clear consensus,” and that the empirical work “is sparse and suffers from essential limitations.” Her conclusion is that while there are some indications that corporate taxation reduces wages, the preponderance of evidence finds no effect at all.

In further thinking about who actually pays the corporate income tax, it’s worth looking at two big reasons why some economists think capital can skirt it. First, capital is far more mobile that labor. The thinking goes that if a country or state increases its corporate income tax, then capital can easily move to a new, lower-tax location and get a higher return there. This ability to leave ends up pushing the incidence onto workers who are far less likely and able to move locations.

Tax rates, however, are far from the only reason why corporations locate somewhere. California has a very high corporate tax rate for a state, but one out of nine establishments in the United States is located there. The reason is that firms often need or want to be close to each other. In the case of California, think of Silicon Valley. A company might find it worthwhile to stay in a location even if the tax rate gets hiked a bit. So firms are less mobile than some research papers and economist might think due to the benefits of location. The result is that capital would bear more of the tax burden.

At the same time, models of tax incidence often assume that the return on capital earned by shareholders are the “normal” return you’d get from a risk-free investment. But most of the profits that corporations earn and on which they are taxed are not from risk-free investments but rather from “excess returns,” or profits derived from riskier investments or companies’ market power in their respective marketplaces. (The discussion of the incidence of the U.S. corporate income tax on page 17 of this Congressional Budget Office report makes this point well.) A tax on these returns would be borne even more by capital, which means a tax cut wouldn’t lead to significant wage gains.

So a broad look at the evidence doesn’t deny that some portion of the U.S. corporate income tax is borne by workers. It just appears that it’s not a significant portion and therefore unlikely that a reduction in the tax rate would do very much to boost wages for U.S. workers.

(Photo by Susan Walsh, Associate Press)

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