Corporation tax: Why it’s workers who really pay when we squeeze firms

Ben Southwood
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WHEN One Direction (1D) weighed in on the corporation tax debate, calling on their fans to pressure George Osborne into “cracking down on company tax avoidance”, it was the clearest indication yet that business tax has become a popular issue. But what has not filtered through to the public debate is the question of who bears the economic burden of this tax – is it fat cats, or could it secretly come out of wages or turn up in higher prices?

If this is confusing, this is because, for economists, a tax’s burden is borne by who it makes worse off. For example, though shops hand over VAT to HMRC, it is generally accepted that consumers bear the burden through higher prices. And while employers hand over national insurance contributions, economists tend to think this money comes at the expense of lower wage offers than there would otherwise be.

Since companies are just legal constructs, they cannot bear any of the burden of corporation tax themselves. Instead, the most likely burden-bearers are workers, who may get lower wages, consumers, who might face higher prices, or shareholders, who might receive lower dividends or see their shares worth less.

1D may be surprised to discover that, according to the empirical studies I have pored over in my research, it is workers, not capitalists, who suffer most when corporation tax rises. Even excluding the highest results to get a very conservative estimate, I found that, according to the average empirical research paper, 57.6 per cent of the burden of corporation tax is borne by workers in the form of lower wages.

This exclusion is important, because some well-cited papers find a much higher result. According to Kevin Hassett and Aparna Mathur’s 2006 paper, causing firms to pay an extra $1 in tax leads to approximately $22 less paid in wages, effectively a burden of 2,200 per cent. R Alison Felix’s 2007 paper found that 400 per cent of the size of a change in corporation tax revenues came out of worker pay.

How does this happen? First, higher corporation tax means less profit for firms and workers to bargain over. Second, higher corporation tax means less relative reason to tie up investment in capital as opposed to consuming it in general, and in particular less relative reason to tie up investment in capital in a given country. Less capital per worker means lower productivity, and lower productivity means lower wages.

There are endless complications and the debate is ongoing – while the empirical estimates of the worker share I found ranged from 0 per cent to 2,200 per cent, some theoretical results thought workers might even benefit.

But if anything, this is an extra reason to be sceptical about corporation tax – we aren’t even sure who pays it. If it turns out not to be a stealth tax on workers, it’s a capital tax, which economists almost unanimously believe is a particularly distortionary and inefficient way to raise revenue.

At best, corporation tax is a stealth tax on workers. At worst, it is a highly distortionary investment-reducing capital tax. In this week’s Budget, the chancellor is expected to cut it 1 percentage point: he should go much further. Let’s hope it doesn’t take a petition from 1D fans to convince him.

Ben Southwood is head of policy at the Adam Smith Institute. His paper Who Pays Corporation Tax is out today.