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1 1 (September 29, 2017)

handle is hein.crs/govcgvu0001 and id is 1 raw text is: , . ' riES- - $r h ,i , Who Pays the Corporate Tax? p\w -- , gnom go mppm qq\ , q I MM 11LULANJILiM, September 29, 2017 Among the issues surrounding tax reform is who bears the burden of the corporate tax. The burden could fall on stockholders, on capital owners in general, or on labor. This question is important for characterizing the distributional effects of the tax. If the tax reduces the returns to capital, it falls largely on higher-income individuals who own relatively more of capital assets and is progressive (i.e., the tax rises as a share of income as income rises). If it reduces wages, it falls on workers and it is less likely to be progressive. A considerable amount of economic research has appeared, especially in the past 10 or 15 years, examining the incidence of the tax. That research is reviewed in detail in CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by Jane G. Gravelle. That review suggests that the evidence supports most or all of the burden falling on capital. Sometimes claims are made that the tax falls on the corporation's customers (and by implication on purchases in the economy). Only relative and not absolute prices matter in determining burden and aggregate real prices cannot rise in the economy due to taxes. A corporate tax would raise the prices of corporate goods but at the same time lower the price of noncorporate goods, with the overall effect on prices zero. Therefore, economic research has focused on which factor of production (labor or capital) bears the burden, which is the more important issue for distributional issues. This research reflects two different approaches to empirical estimates of the burden: embedding behavioral responses in a general equilibrium model and reduced-form statistical estimates. Since the 1960s, the standard approach to studying the corporate tax burden was through a general equilibrium model. The model that prevailed for many years was one with a closed economy with a fixed capital stock. This model shows that the burden falls on capital. The corporate tax causes the return in the corporate sector to fall, and capital moves out of that sector and into the noncorporate sector. The contraction of the capital stock in the corporate sector causes the rate of return before tax to rise, restoring some of the original after-tax return, whereas the abundance in the noncorporate sector causes the rate of return to fall, spreading the burden to other capital income. It also causes prices to rise in the corporate sector and fall in the noncorporate sector. With a reasonable set of empirical assumptions, wages were largely unaffected and the burden fell around 100% on capital (both corporate and noncorporate). It could slightly exceed 100% or slightly fall short, but was always close to 100%. Economists then began applying the model to an open economy in which the tax could cause the capital stock to contract because capital could flow out to other countries. An important advantage of a model is that it can set the limits of what might be expected. The first, simplest, models suggested that significant taxes could fall on labor. In the case of a small open economy with one good and with perfect capital mobility (i.e., investment flows to the highest rate of return regardless of location) and where foreign and domestic products are perfect substitutes, the full burden of the tax falls on labor income. Capital flows out of the country to the rest of the world causing the pre- tax return to rise and because prices must remain fixed (due to perfect product substitution) and capital owners must earn their original after-tax return, only the wage rate adjusts, falling enough to offset the rise in the pre-tax return. These are strict assumptions; as they are relaxed, the burden is more likely to shift to capital. For example, applying the model to a larger economy causes part of the burden to fall on capital. Empirical evidence also suggests that capital is not perfectly mobile (i.e., investing abroad is not a perfect substitute for investing at home). Relaxing that assumption causes a larger share to fall on capital as capital cannot move as easily. Similarly, making foreign products imperfect substitutes for domestic products makes the economy less open and, again, causes more of the burden to fall on capital. Overall, using values from the empirical literature for the three major behavioral effects (how easily substitutable capital is across jurisdictions, how easily substitutable foreign products are for domestic ones, and how easily capital can be substituted for labor in production), as well as how capital intensive the corporate- tradable sector is compared with the economy as a whole, labor appears to bear between 20% and 40% of the burden; hence, the majority falls on capital. This analysis likely still places too much of the burden on labor for several reasons. First, some share of the profit that generates taxes is in the form of rents with the burden borne entirely by stockholders. Although little evidence is available on the share of rent, that evidence suggests a share of 10% to 20%. This share suggests a range of 15% to 36% falling on labor. Strictly speaking, the analysis applies only to a source- based (territorial) tax in which the U.S. corporate tax applies only to profits earned in the United States. The U.S. .O 'T

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