Oxford University Centre for Business Taxation
Corporation tax and social welfare
What are the social costs of corporation tax?
All taxes distort the behaviour of private economic agents, but some do so more than others. Economists have recently investigated the costs associated with high rates of personal income tax – which could arise from lower effort or moving to a different jurisdiction, as well as the real costs associated with evasion and avoidance. Recent research by Michael Devereux, Li Liu and Simon Loretz has developed techniques for assessing the costs of taxes on corporate profit.
This research uses data from the population of UK corporation tax returns between 2001 and 2008 available in a new secure Datalab in HMRC. The empirical procedure is to estimate the elasticity of corporate taxable income with respect to the statutory corporation tax rate. Under certain circumstances, this elasticity can be a 'sufficient statistic' for evaluating the social costs of corporation tax – measured by the 'marginal deadweight cost'. Devereux and Li also developed a method for assessing how far differences in personal and corporate taxes affect the share of total income declared in the two different forms.
The research exploits two types of variation in corporation tax rates to identify the effects of the tax. The first arises from a number of reforms to the corporation tax regime for small companies, including the introduction, reform and abolition of a starting rate between 1999 and 2006. The second arises from discrete changes to the marginal tax rate at various points in the tax schedule. For example, in some years, the marginal tax rate jumped from zero to 23.75% as profit increased above £10,000.
Overall, the results suggest that at profit levels around £300,000, the marginal deadweight cost of corporation tax is around 8% of the revenue collected. But at lower levels this was much higher at around 25% of revenue – that is, for every additional £4 of tax revenue generated from small companies, the cost to the companies is around £5.
Which workers bear the burden of corporate taxation and which firms pass it on?
The question of who bears the burden of the corporate income tax is important and controversial. Proponents of higher taxes on business argue that these taxes mostly fall on firm owners and thus redistribute income from ‘rich to poor’. Critics object that higher taxes on profits will not be borne by capital because capital is internationally mobile, with the burden of higher corporate taxes will be shifted to immobile factors of production, in particular, labour.
Empirical evidence on this question is scarce, especially on the type of labour which is most affected. This research provides evidence on the effects on wages of the German business tax, which is set at the municipal level. We use rich administrative linked employer-employee panel data, covering 11 years, and link it to data on the business tax rates of about 11,500 German municipalities. On average 8% of the municipalities adjust their business tax rate per year, and we use this variation to identify the tax incidence on wages.
Our central estimate is that a 10% increase in the effective corporate tax rate (say from 30% to 33%) reduces wages by 1.8%, an effect that takes two years to occur. This is largely borne by incumbent workers. Worker groups that are more vulnerable, such as low-skilled workers, women, part-timers and individuals with low firm-specific tenure share a relatively higher burden of the tax.
We find significant differences in this effect on wages between industries. Following economic intuition, firms shift a larger share of the tax burden to their workers if the wage bargaining takes place at the firm level rather than at the sectoral level and if wages exceed the minimum wage stipulated in a collective agreement. More profitable firms shift less of the burden.
Measuring the incidence of corporation tax
An important and yet still open question is who bears the effective burden of corporation tax. This research takes a new approach to measuring this, by exploiting differences in effective marginal tax rates between industries and over time using US data. The empirical results suggest that the labour force bears a significant part of the burden of the corporate income tax. In addition, the research finds that the elasticity of wages with respect to the corporate effective marginal tax rate increases with industry concentration. On average, this approach suggests that a one dollar increase in corporate tax revenue reduces wages by around 60 cents.