The direct incidence of corporate income tax on wages

Abstract

We examine the extent to which taxes on corporate income are directly shifted onto the workforce. We use data on 55,082 companies located in nine European countries over the period [1996][1997][1998][1999][2000][2001][2002][2003]. We identify this direct shifting through cross-company variation in tax liabilities, conditional on value added per employee. Our central estimate is that the long run elasticity of the wage bill with respect to taxation is -0.093. Evaluated at the mean, this implies that an exogenous rise of $1 in tax would reduce the wage bill by 49 cents. We find only weak evidence of a difference for multinational companies. This paper re-examines the extent to which taxes on corporate income are passed on to workers in the form of lower wages. We make two main novel contributions. First, we model a new mechanism by which corporate taxes may be passed on in lower wages: the wage bargain. We differentiate two aspects of the effective incidence of the tax. Differently from previous contributions, we identify the direct incidence of the tax:given the pre-tax profit of the firm, a higher tax bill will directly reduce the quasi-rent over which the workers and the company can bargain. The indirect incidence instead has an effect on wages through determining the level of pre-tax profit, by affecting either investment or output prices. Second, we test the size of this effect using unconsolidated firm-level accounting data for over 55,000 companies in nine majorEuropean countries over the period 1996 to 2003. Variations in tax payments and effective tax rates arise due to both differences across countries and over time in the Nonetheless, despite its policy relevance, until very recently it received virtually no econometric investigation. 1In a 1994 survey of North American tax professionals undertaken by Slemrod (1995), 75 per cent of respondents believed that corporate income taxes are largely passed on to workers and consumers.2 legal tax system, and due to firm-specific factors. We identify the effects of taxation using all of these sources of variation.The literature on the incidence of taxes on corporate income dates back to Harberger (1962), who developed a model of a closed economy with a corporate sector and a non-corporate sector, and analysed the introduction of a tax only in the corporate segment of the economy. Harberger (1962) showed that the incidence of the tax depended on a number of factors, including the elasticities of substitution between labour and capital used in each sector, and between the goods produced in each sector.His main conclusion was that under reasonable assumptions, the tax is borne by all owners of capital, across both segments of the economy, as it drives down the post-tax return to capital. A number of more complex CGE models with a larger number of sectors generate similar results (see, for example, Shoven, 1976).However these results depend crucially on among other things, the assumption of a closed economy, which restricts the supply of capital to the economy. If ca...

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