The Corporate Income Tax, Entrepreneurship, and the Noncorporate Sector

Abstract

Harberger's analysis of the corporate income tax depends on his assumption that the corporate and noncorporate sectors produce different goods. This article modifies that assumption while arguing that the distinguishing feature of corporations lies in their ability to raise capital in a large and well organized market. Once this modification is made, the imposition of the corporate income tax has effects markedly different from those described by Harberger. In particular, it induces firms to postpone the decision to incorporate and reduces the cost of capital schedule faced by some unincorporated businesses. The corporate income tax is, in effect, a tax on size. As such, the effect of the tax on the mix of goods produced in the economy is very uncextain. Previous authors have explored the incidence and excess burden of the corporate income tax from a variety of perspectives. Despite the diversity of the resultant literature, it appears that individual contributions can be classified by how they answer one or both of the following questions:(1) How does the corporate income tax affect the cost of capital?(2) Given that the corporate income tax does affect the cost of capital, what are the general equilibrium implications of such an effect?AUTHORS' NOTE: We wish to thank numerous colleagues who have given us their thoughts on earlier drafts. We also would like to acknowledge the invaluable efforts of the editors and reviewers of this journal, who are responsible for many improvements in the article, but, of course, for no remaining errors.

The Incidence and Efficiency Costs of Corporate Taxation When Corporate and Noncorporate Firms Produce the Same Good

“…In treating each sector as consisting of identical firms facing the same tax rate, Harberger ignores the substitution that can arise between corporate and noncorporate producers. Moreover, as Ebrill andHartman (1982,1983) and Cravelle (1981) point out, the Harberger model cannot be easily modified to permit noncorporate production of the corporate good. If there is even a single, equally efficient noncorporate producer of the corporate good, corporate production will entirely disappear in response to the imposition of a tax on corporate income.…”