Why the corporate income tax is paid by people, and the only question is who

A corporation has never eaten a sandwich, never bought a house, never cast a ballot and never paid a bill out of its own pocket, because it does not have one. It is a legal fiction, a contract that lets many people pool money and share risk under a single name. When a politician says "make the corporations pay," he is promising a bill be sent to a fiction. Fictions do not pay bills. People do.

That is the argument of this post, and it is not a conservative slogan. It is the standard position of mainstream public finance economists across the spectrum. The disagreement among them is about a different question, the one that matters: which people?

Terms

Statutory incidence is who the law says must send the money to the government. For the corporate income tax, the law says the corporation.

Economic incidence is who actually bears the cost, meaning whose income is lower because the tax exists. The two are different, and the difference is the whole subject. A sales tax is collected by the store but paid, in higher prices, by the customer. A payroll tax is split in law between worker and employer, and economists have long argued that the worker bears nearly all of it through lower wages. The law's label does not decide who is poorer at the end.

Tax incidence is the study of economic incidence. Its first rule is that only people bear taxes. A business collects a tax and passes it somewhere: to owners as lower returns, to employees as lower wages or fewer jobs, to customers as higher prices, or to some mix of the three.

The argument in four premises

1. A corporation has no income of its own that does not belong to someone. The profits it earns belong to its shareholders, whether they are direct owners or beneficiaries through a fund.
2. A tax on corporate profit therefore reduces what someone, a shareholder, a worker or a customer, would otherwise have.
3. Which people bear it depends on how easily capital and labor can move, and on how competitive the markets are.
4. Therefore "who pays the corporate tax" is a question to be answered with evidence about incidence. Any policy defended as "making business pay" has skipped the question.

None of these premises is partisan. They are what any textbook says. What follows from them is uncomfortable for both parties.

Three places the dollar can land

Take a concrete case, labelled as a hypothetical. A manufacturing firm earns $100 million before tax. The corporate tax takes 21 percent, which is $21 million. Where does the $21 million come from?

Owners. If the firm cannot raise prices and cannot cut wages, the $21 million comes out of what owners would have earned. Their return on the capital they invested falls. Less return means less incentive to invest, and over time less capital in the economy.

Workers. Capital that earns less after tax goes elsewhere, or is not invested at all. A factory that would have been built is not built. A machine that would have raised a worker's output is not bought. With less capital per worker, a worker's output is lower, and wages, which follow productivity over time, are lower than they would have been. The cost lands on workers slowly and invisibly, as a raise that never arrives.

Customers. If the firm can raise prices, some of the $21 million is recovered from buyers. This is more likely in markets with little competition and less likely in a global market where a foreign rival is not taxed at the same rate.

In reality it is some of each, and economists differ on the mix. That is where the evidence enters.

What the official scorekeepers assume

The Congressional Budget Office and the Joint Committee on Taxation are the two agencies whose estimates drive the congressional debate. When they distribute the burden of the corporate tax across households, neither assigns all of it to the owners of capital. Both assign a substantial portion, roughly a quarter in CBO's published method, to labor, meaning workers bear it through lower wages, and the balance to owners of capital. The Treasury's own staff has used a smaller share to labor, about 18 percent in one published method. Read the methodology notes yourself, because they are published.

Notice what this means. The agencies that the left trusts to score tax bills accept the premise that workers pay part of the corporate income tax. A proposal sold as "making corporations pay" is a proposal that, on the official scorekeepers' own assumptions, lowers workers' pay by some amount. The disagreement over how large the labor share is, and whether it is higher in an economy where capital moves freely, is real and unsettled. The existence of a labor share is not in dispute.

Capital crosses borders

This is the part that students of the Founding should appreciate. Alexander Hamilton understood in the 1790s that capital is mobile and goes where it is treated well. His reports on public credit and manufactures were aimed at making America a place where capital would stay and grow. Capital today moves far more easily than in 1790. A firm can book profits in one country, build a plant in another and incorporate in a third.

When one country taxes corporate profit more heavily than its neighbors, three things can happen: firms invest less at home, they move the location where profits are reported, or they move the investment itself. Each reduces the base on which the tax is collected, and each hurts workers who would have worked at the new plant. The reduction of statutory corporate rates in many countries over the past decades reflects this competition.

The United States saw this in action. For years it had one of the highest statutory corporate rates among developed countries, 35 percent at the federal level, and some American firms responded by "inverting," that is, merging with a foreign company and relocating their legal home abroad. The 2017 law cut the federal rate to 21 percent, and major inversions largely stopped, though other provisions of that law also bear on the decision to invert. We tell that story in the corporate rate cut to 21 percent and the inversions it brought to an end. Whether the cut paid for itself is another matter, and I will not claim it did; the honest accounting is in where tax cuts pay for themselves and where they honestly do not. The narrow point is that capital reacted to the rate, as the incidence argument predicts.

The double layer

There is one more feature of the corporate tax that is easy to miss. Corporate income is taxed twice. First, the corporation pays tax on its profit. Then, when it distributes some of the remainder as a dividend, or when the shareholder sells the stock at a gain, the shareholder pays tax again.

An illustration with invented, round numbers, not an actual schedule: a firm earns $100. At a 21 percent corporate rate, it pays $21 and has $79 left. It distributes the $79 as a dividend, and the shareholder owes a tax at an assumed 15 percent, which is $11.85. The shareholder ends with $67.15. Total tax: 21 plus 11.85, which is $32.85 on $100, or 32.85 percent. Compare that with a $100 earned as a sole proprietor, where one layer of tax applies. Corporate income bears an extra layer relative to income earned in other forms. This discourages the corporate form, encourages debt over equity financing, since interest is deductible and dividends are not, and rewards clever structuring. Each of those distortions is a cost with no corresponding benefit. For the capital gains half of this story, see capital gains taxes and the lock-in effect that keeps money frozen in place.

The steelman, in the best words its defenders would use

Fine, say the defenders of the tax. But look at who owns stock. Ownership of corporate equity is highly concentrated at the top of the income scale. Even if workers bear a share, shareholders bear most of it, and shareholders are the wealthy. A tax on corporate profits is therefore a tax on the rich, with a side effect on workers that is modest and uncertain. Without it, corporate income earned by wealthy owners would escape tax until they sold their shares, and then perhaps never, if they held assets until death. The corporate tax is a backstop to the personal income tax.

That is the best version, and it deserves a real answer. I will give it in four numbered points.

1. Concede what is true. Stock ownership is concentrated. A substantial portion of the economic burden of the corporate tax falls on owners of capital, and wealthier households own more of it. No honest economist denies that.

1. But much of the stock is owned through retirement and pension accounts. Millions of workers own corporate equity through 401(k) plans, individual retirement accounts, and defined-benefit pension funds, and so do teachers' and public employees' retirement systems. When the corporate tax lowers returns on the stock those funds hold, it lowers the retirement incomes of the people they serve. These holders do not appear as "wealthy shareholders" in a quick survey. They are ordinary people whose savings sit in funds. The corporate tax reaches them without anyone mentioning it.

1. The backstop argument is an argument about the personal tax, not for the corporate tax. If the problem is that gains escape tax at death or are deferred indefinitely, the targeted remedy is to change the rules for gains and estates. A flat tax on corporate profit hits the retirement saver and the billionaire alike and has no way to tell them apart.

1. The tax is hidden, and that is its political appeal and its flaw. A tax people do not see is a tax that is easy to raise. A voter who is asked to approve a higher rate on "big corporations" does not know that he is lowering his own pension returns or his future wages. That is a transparency problem, and a republic should dislike it. A tax on income that appears on the paycheck is at least a tax the citizen can see and judge.

What the Founding contributes

The Framers gave Congress power to lay and collect taxes in Article I, Section 8, and asked that duties, imposts and excises be uniform. They did not mention corporations, because the modern business corporation was rare in 1787. But their reasoning about taxes is worth recalling: they preferred taxes that citizens could understand and that fell on identifiable payers. In Federalist No. 12, Hamilton argued that a nation's revenue depends on the prosperity of its commerce. The point is no less true for being old. A tax that drives away the activity it taxes raises less money than its framers hoped and does more harm than they intended.

Where this leaves the debate

Several claims follow, and I will state them as plainly as I can.

First, calling the corporate tax a tax on "business" or "corporations" hides who pays. It should be called what it is: a tax on shareholders, workers and customers in a proportion that economists debate. Politicians who want to be honest should say which group they intend to tax.

Second, the case for taxing capital income is a respectable one, and some conservatives and liberals alike favor an alternative design, such as a lower rate on corporate profit combined with a tax on distributions, or a cash-flow tax that lets firms deduct investment immediately. The design choices matter more than the headline rate.

Third, the corporate rate belongs in a larger comparison of the tax system. A system that taxes income earned and saved more heavily than income spent discourages saving and investment, which is where wages come from. A consumption-based design avoids that bias. We compare some of those options in A flat tax, a national sales tax and a VAT, compared for one family.

Fourth, none of this means corporations are above criticism. Subsidies, bailouts and regulations that favor incumbents are separate sins, and conservatives should oppose them as readily as the left does. See big companies love the regulations their small rivals cannot afford. A free market is not the same as a favor for every large company.

The case in brief

1. A corporation is a legal form, so every dollar of corporate tax is borne by shareholders, workers or customers. Only people pay taxes.
2. The official scorekeepers agree: CBO and the Joint Committee on Taxation both assign a meaningful share of the corporate tax to labor, and the rest to owners of capital.
3. Capital is mobile across borders, so high corporate rates shrink the tax base, reduce domestic investment and push down wages, as the inversions before the 2017 rate cut illustrated.
4. Corporate income is taxed twice, which in a round hypothetical gives a combined rate of 32.85 percent against a single layer for other forms of income.
5. The objection that shareholders are wealthy ignores the pension funds and retirement accounts through which ordinary families own stock, and it points to the personal tax, not the corporate tax, as the right place to reach large fortunes.

What you can do: when a candidate or a bill promises to make corporations pay, write to the office and ask which group of people, shareholders, workers or customers, the sponsor expects to bear the cost.