Scott Sumner  

Some comments on tax incidence

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If corporations are greedy, why don't corporations also pass corporate income taxes on to consumers? Why do most people seem to believe the opposite?

It's disappointing that so many people uncritically accept the claim that taxes on corporations are absorbed by owners.

Consider the excise tax on gasoline, which is imposed on corporations like Exxon and Chevron. Is this tax on corporations absorbed by owners, or passed on to consumers? I think if you polled 100 economists and 100 non-economists, all 100 non-economists would claim that the excise tax on gasoline is passed on to consumers, whereas some of the economists would argue that the burden is shared between gasoline consumers and stockholders of the oil companies. (The economists are correct in this case.)

So it seems like the public is especially likely to believe that corporations simply pass taxes on to consumers. If asked why, I suppose they'd say something about big oil companies being "greedy". OK, but then why doesn't that apply to corporate income taxes? If corporations are greedy, why don't corporations also pass corporate income taxes on to consumers? Why do most people seem to believe the opposite?

It's obvious that peoples' gut instincts on this question are completely useless. Most people believe that corporations pass gas taxes on to consumers, but absorb the corporate income tax. But if asked why, they'd be utterly incapable of providing any sort of coherent explanation.

So we are left with the views of economists. Surely they can answer this question! There must be some sort of economic model that tells us who absorbs the corporate income tax. Unfortunately they are lots of models, all very stylized and none of which are even remotely persuasive. Some models say workers absorb the tax, others say the opposite.

I don't doubt that you can find polls that show that most economists believe that more than half of the corporate income tax is absorbed by owners. But I've seen polls that show that 95% of economists believe that fiscal stimulus is effective, despite overwhelming evidence that it is not. So much for polling economists.

I focus on efficiency, not distribution, because we really don't know much at all about how to fix distributional issues and we know a lot about how to improve efficiency. If it was easy to improve living standards through distributional policies then the French would be better off than the Swiss, but actually the reverse is true. (Switzerland is richer and happier.) Progressives have no answer for why that is. I do have an answer; Switzerland has a much more efficient policy regime. For that matter, so does Sweden.

People who obsess about distribution think that there is a vast difference between living standards in Sweden and Switzerland. People who obsess about efficiency think that there is a vast difference in living standards between Switzerland and Venezuela. Which view seems right?

Screen Shot 2017-12-17 at 1.06.09 PM.png
The graph may be hard to read. Eyeballing the data, it looks like G/GDP is about 33.5% for Switzerland, 37.5% for the US, 49.5% for Sweden, and 56.5% for France.

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COMMENTS (19 to date)
Lewis writes:

This analysis seems willfully obtuse. The gasoline market is somewhat competitive. Much corporate income comes from trademarks, intellectual property, brands, etc. Fixed factors. If you cut the tax rate, sure maybe after fifty years the savings are passed on to consumers, but lots of income shows up in savings for these fixed factors. Why else would Wall Street be predicting so much higher profits from the tax cuts? Is it all productivity growth?

Consider Google. The search is free. How could they pass on their savings to consumers? It's good that they are now incentivized to push ahead on their other businesses, like AV's. But much of their savings will simply go to profits. Maybe you could poke holes in this particular example but you get what I mean: some income comes from near monopolies with very low marginal cost. From what I can tell, as far as search, the only extra incentive google will have is to spend more on customer acquisition for advertisements. Awesome.

Why do you talk about efficiency while neglecting one of the chief concerns: the huge distortions introduced by the avoidance possibilities the bill opens up. This not only makes the bill much more deficit-inducing than otherwise---thereby hurting investment/exports---it encourages wasteful avoidance activity and ownership structures.

Here is a paper by a bunch of law profs

This is going to a huge boon to the accounting and tax law industries. That doesn't sound like efficiency to me.

Quite Likely writes:

"People who obsess about distribution think that there is a vast difference between living standards in Sweden and Switzerland. People who obsess about efficiency think that there is a vast difference in living standards between Switzerland and Venezuela. Which view seems right?"

This seems a bit strawmanish...

Nobody on the pro-redistribution side is indifferent to wealth levels. The argument isn't "which is more important, an equal distribution of wealth or total wealth" it's how we maximize utility given the declining marginal utility of money. On that basis we should all be able to agree that any efficiency gain that doesn't increase inequality is a good thing, and any redistributive effort that doesn't reduce efficiency is a good thing. Then we can argue about the grey area of efficiency gains with bad distributive effects and redistribution with bad efficiency effects. But let's leave out the "these redistribution-mongers would rather we all be poor as long as we're equal" nonsense.

jc writes:

Yes, many simply want to punish "the rich" or "corporations". This urge will find culturally appropriate outlets, and people will then find logical reasons to support this sentiment and these outlets. Cue Robin Hanson, Steven Pinker, etc.

Most never consider the possibility that consumers (aka "everyone") and employees (current and/or those that might have been hired) may be who they're punishing when they indulge this urge. And those who do will indeed try to believe that corporations and their fat-cat owners/high-level employees will bear the cost.

But here's the thing about corporations and their owners..."shareholders" are not a monolith of fat-cats.

My sister is a schoolteacher whose retirement is being funded by CALPERS. A huge number of working class people invest so that they can retire, put their kids through college, etc.

So even if you've thought it through and reject arguments about consumer/employee incidence or harmful've basically stuck it to my sister.

And if the progressive view that X% of a multi-millionaire's income is nothing to them, while X% of a poorer person's income might mean everything to them, hence the need for a progressive tax system where the rich pay 2X, 5X, etc...well, then the pain you've caused my sister, the schoolteacher, hurts a lot, while the pain felt by the rich was very small.

But - ask the communists - it's really hard to overcome urges that seem hardwired into human nature. Logical arguments won't do the trick. :)

Bob Murphy writes:

Great point about the gasoline tax, Scott.

Quite Likely writes:

"But I've seen polls that show that 95% of economists believe that fiscal stimulus is effective, despite overwhelming evidence that it is not."

You can't really believe this can you? You must be making a point about how sensible monetary policy would be make fiscal stimulus unnecessary and cancel out the effects of attempted stimulus, not actually saying there's no effect right?

Otherwise... jeez. Preferring monetary stimulus is one thing, but denying that fiscal stimulus is even possible is getting ridiculous.

Tom P writes:

I suspect there may be an important difference between the gas tax and the corporate income tax: the corporate income tax is assessed on profits, while the gas tax is assessed on sales.

Because the corporate income tax is assessed on profits, it means that shareholders get to keep a fixed fraction of pretax profit. So they simply set prices to maximize pretax profit. In other words, the actual tax rate does not affect the pricing behavior of the firm, and thus a tax cut will not be passed on to consumers (except to the extent that it causes greater capital investment and raises wages eventually through that channel).

The conclusion is the same if the market is perfectly competitive and the firm is a price-taker: in that case, price equals pretax marginal cost, which is not affected by the tax.

But, please correct me if I'm wrong.

Effem writes:

It may be that in one case (the gas tax) some people envision a highly competitive industry (like oil) but in another scenario they envision an industry earning-above-market returns thus indicating a lack of competition. Both would be correct.

MikeP writes:

I focus on efficiency, not distribution, because we really don't know much at all about how to fix distributional issues and we know a lot about how to improve efficiency.

Indeed. Along these lines is the constant whine that there is no evidence that companies will use lower tax rates to invest their profits in building their own business or raising their own workers' wages. No. These newly freed cash assets will be used to reward executives, pay dividends, and finance stock buybacks. So it's useless to cut corporate taxes!

But that's not how economies work. One should look at a pile of cash that a company has and realize that that company should not be sitting on that pile of cash: they clearly do not know what to do with it. Much better would be for the company to distribute the pile back to the owners who are unlikely to stuff their mattresses with it and where it would find lending and investment opportunities and grow the wealth of the economy at large.

Lewis writes:

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Trent McBride writes:

Things that irritate me about this whole debate:

1. The absolute refusal, mostly on progressives who should know better (cough VOX cough), to even consider tax incidence questions, or to even consider that the type of tax (consumption, income, investment) matters, independent of their distributional wet dreams.

2. The unstated assumption that taxes can only get higher and more progressive. I mean, the top rate has only existed for like 5 years, yet it is some unprecedented tragedy for it to come back down (not even all the way).

3. There seemed to be collusion on the part of journalists to convince the entire middle class, who were always more likely to get a cut, that they were all seeing an increase.

I don't know what the overall outcome of this package will be, but getting rid of the corporate tax and paving the way to eventually get rid of SALT and MI deductions were huge, and probably worth it. I never thought I would see that. Anything else that was a mistake can be fixed.

Scott Sumner writes:

Lewis, You are attributing views to me that I do not hold.

I never denied that corporate income taxes can take away some of the rents earned by firms with intellectual property rights. Nor did I deny that corporations would gain significantly in the short run. Neither of those claims disprove my argument. Surely you don't think most profits are rents? Or that the short run effect is more important than the long run effect? (Corporate profits as a share of GDP are only slightly higher than in the mid-1960s, when there was no Google, Facebook or Apple.

I have posts criticizing our IP rules, which I believe are too generous to patent and copyright holders. Government regulations also create large barriers to entry, which helps big corporations.

I have many posts criticizing the complexity of the tax code, and also the fact that this bill will lead to much larger deficits. I'm not even saying it's a good bill, I have very mixed feelings on the whole thing. But don't forget that cutting the rate to 21% tends to reduce the incentive to do costly tax avoidance strategies, so it cuts both ways.

Quite, You could also say your position is "strawmanish". I have many posts advocating progressive taxation. My point is that there really isn't much evidence that it matters beyond a fairly basic level. If we think about the progressive agenda in America, you might characterize it as making us less like Switzerland and more like Sweden. My claim is that there is very little evidence that this would do much good. In contrast, there is a lot of evidence that making our economy more efficient would make living standards higher. That's the margin where we should be focusing out efforts. But yes, the utilitarian argument for some redistribution is strong. The question is how much. The US government already spends as much on health care as European governments (about 8% of GDP), and Bernie Sanders wants it to double it to 16%. For what purpose?

You said:

"You can't really believe this can you?"

I have many posts explaining the theoretical and empirical support for the claim that monetary offset makes the multiplier roughly zero.

Scott Sumner writes:

Tom, I agree that it's an empirical question, and I certainly agree that corporations absorb SOME of the corporate income tax, just as they absorb some of the gasoline tax.

Robert Barrett writes:

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Fred Anderson writes:

I am not an economist, and the argument I'm about to make will likely reflect my ignorance. Even so, here it is. I would appreciate feedback.

Doesn't the incidence of a tax depend on the parties' relative power? And doesn't their power depend on their available options? So between capital, customers and workers, won't these taxes mostly get passed to those least able to escape them?

Consider capital. If a new tax falls upon the capital suppliers, that will lower their ROI for this investment. But capital suppliers have a plethora of alternative investments available to them at the click of a mouse. Passing the tax on to the capital suppliers will make it harder to acquire new capital: That new capital being needed for growth, or to replace our old capital structure as that wears out.
Admittedly, old capital may be stuck; there's no way for them to get their funds back out. But through their control of management, they at least don't have to engage in internal investment into what is now an inferior deal. I really wonder how much foreign investment (e.g., into China) has been driven by voter hostility to domestic investment. (Additionally, if management allows old capital to be mistreated, that should also make these firms less attractive to new capital.)
Because capital has easy escape options, I suspect capital does not have to eat much of these taxes.

But perhaps we can pass corporate taxes on to the consumers -- either as higher prices or as reduced quality in the deliverables. For services -- which usually require personal interaction with a server, and hence are difficult to provide at a distance -- this may work. Barring service tourism, consumers are largely stuck with their local doctor, lawyer, educator, plumber, brick-layer, electrician, etc. (And please note the escalating costs in this 75% of our economy -- healthcare, government, K-12 & higher education, home construction, etc.)
Producers of physical goods -- which can be shipped -- may not be able to pass the tax along: These consumers have the option of buying from a foreign supplier who doesn't have to pay those U.S. taxes. (Which leads to the complaint that "everything nowadays seems to be made in China.")

[This Consumer section of my argument is weak, since I don't fully understand the implications of service suppliers organized as non-profits, nor how foreign goods suppliers are taxed by the U.S.]

At least for goods producers, that leaves workers as the next potential target to take the hit. And workers -- at least the ones who lack rare skill sets -- would seem especially vulnerable. Short of learning a foreign language and/or moving out of the country, they're stuck with jobs here. And if your skills are in manufacturing, stuck with a manufacturing job here. Which, for the last ten years, have been in short supply. Many workers had little choice but to hang onto the job they had and bitterly accept slow or negligible growth in wages & benefits -- sometimes along with escalating demands that they learn new technologies. (Which were supposed to increase their productivity. But wouldn't increase their paychecks. Since -- sorry for the cynicism -- the politicians wanted to commandeer those gains.)

[One other unexplored avenue here: Could we pass those corporate taxes on to our suppliers? Especially if, as is commonly the case, the corporate buyer is large and powerful and the parts supplier is much smaller & weaker. I wonder what the composition of our small business population has looked like over recent decades.]

Alec Fahrin writes:

The most unequal societies in the world are generally hellholes with immense social violence and corrupt political systems. Meanwhile the most equal nations are generally first world and socially stable.

Maybe I’m being too simplistic, but it appears that efficient redistribution policies are possible without destroying the basis of free markets and capitalism.

The USA has the worst of both worlds. Inefficient redistributory policies and tons of incentives (pork) for big business and the politically connected. That explains why we have so much poverty and social strife despite our $55,000 per capita.

If we could be more like Sweden and more like Switzerland our GDP growth might slow but our society would be richer in the areas that really matter. This tax cut is a huge deficit boost. Reform that requires massive deficits is not reform. A government deficit is, as you appear to imply, an inefficiency in itself. Furthermore, no matter what you may claim, the vast majority of economists agree that the corporate tax cut will benefit the owners of capital far more. This deficit bill is a redistribution towards the rich and away from the poor.

Oh, and Scott. You may not know this, but the standard deduction expires in 2025. The efficiency expires. The redistribution, from bottom to top, does not.

bill writes:

I believe that some of the changes open up more opportunity to game the system. Lots of time and money will be spent doing so.

jon writes:

That graph seems like a bit of mixed bag if it is intended to support the idea that G/GDP is the critical measure re: living standards.

To the left of the US you have Columbia, Russia, Lithuania and Latvia.

Austria, Belgium and Denmark are just to the left of France, and Finland is to the right.

Do the former have better living standards than the later?

Scott Sumner writes:

Fred, Many of the issues you describe are important considerations---economists use the term "elasticity" to describe how responsive suppliers and demanders are to price changes (including taxes)

Here's an example I like. Suppose that doctors need to make at least twice as much as accountants to make it worth the hassle to go through medical school. Then if you raise taxes on the rich, a certain fraction of people will be discouraged from going to medical school. Eventually the reduced supply of doctors will raise wages enough so that the after tax income of doctors is still twice that of accountants. Obviously this example oversimplifies things, but it does show that in the long run even an income tax can be partly passed on to consumers, something almost no one takes into account when thinking about tax incidence.

Alec, I didn't mention the standard deduction expiring in 2025 because I know enough about American politics to understand that this will not happen.

And I don't agree that growth would slow if the US adopted the Swiss model. Reducing the size of the US government would probably boost growth.

Bill, I agree.

Floccina writes:

Alec Fahrin

The relationship between inequality and niceness of a country is not so strong and causation may run the other way. See here.

BTW If my reading of other posts is correct, Scott supports a very progressive consumption tax (up to 70%) with low or no Corporate tax.

Also tax incidence is difficult and to some extent most everyone bears some part of every tax.

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