Higher Corporate Taxes, Lower Wages

By May 5, 2011Taxation

Excellent discussion of U.S. corporate taxes by Veronique de Rugy Wednesday at NRO’s The Corner, “How Punishing Is the Corporate Income Tax?” The Mercatus Center research fellow addresses the issue often raised by critics of U.S. businesses, that yes, the U.S. corporate tax rate is high, but corporations take advantage of exemptions and deductions. It’s a legitimate issue to raise but should not be considered independently of the U.S.’s reliance on a worldwide tax system.

As it turns out, the U.S. not only imposes high rates, it also taxes corporations on a worldwide basis: Profits made by an American-owned computer plant are subject to U.S. taxes whether the plant is located in Texas or Ireland. Most major countries don’t tax foreign business income. In fact, about half of OECD nations have “territorial” systems that tax firms only on their domestic income.

De Rugy then raises an issue we were unfamiliar with, that is, studies that show a correlation between higher corporate tax rates and lower wages.

In recent years, several much-discussed studies have found that it is likely that much of the burden of the tax is borne not by capital but by domestic labor, in the form of lower wages. For instance, this December 2010 paper by economists Aparna Mathur and Kevin Hassett shows the link between corporate tax rates and the average manufacturing wage (in U.S. dollars) for 65 countries over a period spanning 1981–2005. They find that there is a clear negative link between the two, suggesting that higher corporate tax rates lead to lower worker wages. They test this theory using regressions controlling for a bunch of other factors, and find that a 1 percent increase in the corporate income tax leads to an almost 0.5–0.6 percent decrease in hourly wages.

This is consistent with the results of many recent empirical papers — Arulampalam et al. (2007) , Mihir A. Desai, C. Fritz Foley, and James R. Hines (2007), Felix (2007) — that use real-world data to look at who really pays the corporate income tax. These studies find that between 45 and 70 percent of the cost of the corporate tax is borne by labor rather than shareholders.

Very informative, timely piece.

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