With President Barack Obama and leaders in both parties favoring lower corporate tax rates, Washington seems poised to enact change next year. They need only resolve details like how much the rates should be cut, which tax avoidance strategies should be barred and whether to give manufactures a discounted rate.
If the corporate tax rate is cut, should the rates for dividends and long-term capital gains be increased?
That issue was inadvertently put on the table by a leading free market organization, the American Enterprise Institute. The AEI, as part of its support for cutting the corporate tax, promoted the idea last month that workers, not investors, bear the burden of that tax. In taking that line, however, the AEI has undercut its own argument for tax relief for investors. Indeed, it shifts the debate toward higher taxes on capital gains and dividends and lower taxes on wages.
We’ll follow that logic later. But first, who bears the burden of the corporate tax? Is it the owners of a corporation, through a lower return on their investments, or is it workers, through lower wages? This question is endlessly debated by economists.
Many people assume corporations just pass the corporate tax on to consumers through higher prices. This is true for monopolies, such as corporate-owned electric utilities, whose prices are set by governments. But it is not true in a competitive market.
The idea that owners bear the tax burden took hold after economist Arnold Harberger wrote a 1962 paper that quickly became a classic of tax economics. I studied his work in more than one economics course in the late 1960s and into the mid-1970s.
When that paper was written, the United States dominated industrial production, the legacy of the devastation of World War Two on the economies of Japan and Europe. As global manufacturing increased, Harberger, who taught at the University of Chicago, refined his theory. In later works, Harberger wrote that while the corporate tax burden falls on owners in a closed economy, in a global economy, where capital flows freely, the burden shifts toward workers, who cannot move so easily.