One year ago, presumptive Democratic nominee for president Joe Biden proclaimed that “nobody making under 400,000 bucks would have their taxes raised. Period.” Now planning a multitrillion-dollar spending splurge (largely masked as an infrastructure plan), the president proposes to pay for it by raising taxes on high-income individuals and corporations. While a corporate tax hike might not at first glance seem like a violation of the president’s prior tax pledge, the empirical evidence demonstrates that American workers ultimately pay the bulk of the cost of corporate tax increases.
Early theoretical models observing the incidence of corporate taxation claimed that capital, not labor, bears the lion’s share of the costs of corporate tax increases because these taxes reduce the profits that benefit corporate executives and shareholders. Economists such as Arnold Harberger based these early economic theories on the assumption of a closed economy, fixed labor and capital supply, and the absence of international investment flows. However, in the six decades since Harberger published his early work on the subject, the global economy has become increasingly open. Foreign direct investment in the United States (as a share of GDP) has grown 15-fold since 1970, international trade has exploded to 60% of global GDP, and the early assumptions of economists like Harberger have been turned upside down.
Recognizing this dramatic shift in the dynamics of the global economy over the past half century, Harberger later revisited his earlier research on corporate tax incidence and reversed his claims that capital bears the cost of tax increases. Harberger’s later work notes that in an open-economy model, changes in the corporate tax rate “can only be reflected in the wages of labor and in the prices of non-tradable goods” and that ultimately “a higher corporation income tax will lead to a lower capital stock and to a lower level of real wages.”
In recent years several empirical studies have examined the incidence of corporate taxation, with the bulk of the economic literature supporting the revised hypothesis of Herberger—that labor (workers) bears the cost of corporate taxes. A study by the Congressional Budget Office found that labor’s burden equals about 73% of corporate tax revenue. In a similar vein, a Federal Reserve study found that a 10 percentage point increase in the corporate tax rate would reduce annual gross wages by 7%.
More recent analysis of municipal data in Germany finds that for every 1 euro increase in corporate tax revenue, workers end up paying 77 cents, with low-skilled, young, and female employees bearing a larger share of the tax burden. Other studies find labor cost shares ranging from 60% to more than 90%. Regardless of the exact number, the empirical literature shows that workers bear the majority of the cost of corporate tax increases, with most studies showing at least two-thirds of the cost being borne by workers.
So, not only is corporate income tax one of the most inefficient and economically damaging forms of taxation, it is also highly regressive: It places the heaviest cost burden not on wealthy corporations but on the American worker. This shift in cost burden occurs because when the corporate income tax is raised, corporations are faced with the prospect of lost profits. Corporate leadership will often respond to these losses by reducing investment in production by closing business chains or factories, raising prices, or moving production overseas. With lower domestic production come fewer employment opportunities and reduced wage growth for workers. So the populist economic argument that the corporate income tax is a tax on rich corporations is largely based on the flypaper theory of tax incidence—that the burden of tax sticks wherever it first lands, overlooking the unintended costs ultimately borne by workers.
Why, then, do progressive politicians and economists argue that corporate taxation is a tax on business profits and not a tax on workers? The simple answer is the wide use of outdated tax incidence assumptions. The incidence assumptions used by many progressive economists are more closely aligned with the outdated theoretical models of the 1960s than with models that recognize the open dynamics of the global economy today, in which capital is highly mobile and labor is not. While a business can easily move production overseas, it will likely not move its labor force.
Unfortunately, it isn’t just progressive economists who continue to use outdated assumptions about tax incidence. Recent reports from both the Congressional Budget Office and the Joint Committee on Taxation allocate 75% of the burden of corporate income taxes to owners of capital and only 25% to workers.
Given the continued use of outdated assumptions that overlook the preponderance of economic literature, we are likely to continue hearing that corporate tax hikes are a tax on corporate CEOs and large corporate profits. But ultimately it is the average American worker who will pay the lion’s share of proposed corporate tax hikes as a result of lower investment—for example, in production or expansion—and reduced real wage growth. As Congress and the administration entertain new proposals to raise corporate tax rates, they should consider that such proposals will result in a tax hike on the American worker.