Wednesday, May 03, 2006

Corporate Tax Rates

According to a new study by KPMG, the United States and Japan have the two highest corporate tax rates of the more than 80 nations examined. Their tax rates on corporate income are about 40 percent (including corporate taxes at the state and local level), while the rate in the European Union averages about 25 percent.

The report says:
Among nations that changed their statutory corporate income tax rates over the past 12 months, the overwhelming majority cut them, continuing a trend towards lower rates that has persisted for several years. Rate reductions were most pronounced in Europe....This may reflect intensifying tax competition within the EU as a result of the accession of 10 new member states last year and the encouragement EU law and jurisprudence has been giving to capital mobility within the EU.
These new facts are the perfect excuse to reprint a case study from my Principles textbook:

Who Pays the Corporate Income Tax?

The corporate income tax provides a good example of the importance of tax incidence for tax policy. The corporate tax is popular among voters. After all, corporations are not people. Voters are always eager to have their taxes reduced and have some impersonal corporation pick up the tab.

But before deciding that the corporate income tax is a good way for the government to raise revenue, we should consider who bears the burden of the corporate tax. This is a difficult question on which economists disagree, but one thing is certain: People pay all taxes. When the government levies a tax on a corporation, the corporation is more like a tax collector than a taxpayer. The burden of the tax ultimately falls on people—the owners, customers, or workers of the corporation.

Many economists believe that workers and customers bear much of the burden of the corporate income tax. To see why, consider an example. Suppose that the U.S. government decides to raise the tax on the income earned by car companies. At first, this tax hurts the owners of the car companies, who receive less profit. But over time, these owners will respond to the tax. Because producing cars is less profitable, they invest less in building new car factories. Instead, they invest their wealth in other ways—for example, by buying larger houses or by building factories in other industries or other countries. With fewer car factories, the supply of cars declines, as does the demand for autoworkers. Thus, a tax on corporations making cars causes the price of cars to rise and the wages of autoworkers to fall.

The corporate income tax shows how dangerous the flypaper theory of tax incidence can be. The corporate income tax is popular in part because it appears to be paid by rich corporations. Yet those who bear the ultimate burden of the tax—the customers and workers of corporations—are often not rich. If the true incidence of the corporate tax were more widely known, this tax might be less popular among voters.