Why We Can Literally Tax “Evil Corporations,” But Not *Really* Tax Them
May 4th, 2010 . by economistmomDonald Marron takes the “throne” at the Tax Policy Center in less than two weeks, and he’s already showing his wisdom on tax policy. Today on his blog he talked about the “bank tax,” aka the “Financial Crisis Responsibility Fee”–from the Administration that can never say “tax” no matter how evil the entity on which said tax would be imposed. Donald was focused on the issue of whether revenue from the bank tax would actually be used to reduce the deficit/pay back the TARP money owed (as the Administration claims it would), or whether it would be grabbed up by all the other more exciting ways to use the money–for example, more tax cuts!
But I liked the little lesson in tax incidence that Donald gave on the way to posing his budget question (emphasis added):
As noted by other participants in today’s hearing, the bank tax raises a host of questions: Is it possible to design the tax so that it is ultimately paid by major financial institutions (by which I presume Geithner means their shareholders and top management), or will it get passed through to their customers? How much, if at all, would the tax reduce bank lending? Is it fair to target the banks even though the bank part of TARP actually made money for taxpayers? Would the tax reduce risks in the financial system?
You see, no matter how the tax is literally (statutorily) structured and who would actually be responsible for writing the check to the government (such as an “evil corporation” perceived as deserving of that tax), the true economic burden of the tax must ultimately fall on some real people. You can say you’re only taxing “companies” and not “people,” but what you’re really doing is indirectly taxing people, rather than directly taxing people. When a tax is levied on a business rather than on a household, the burden must still be distributed among households based on those households’ roles in the various markets in which the taxed business operates–through their roles as workers for that business, investors in that business, or consumers of the goods or services the business produces. A tax on a financial corporation, for example, could end up reducing returns to shareholders of that corporation or reducing salaries of the top management, but it could just as well end up raising the cost of loans to households who borrow to pay for their houses, cars, and college educations–or burdening some households by depriving them of such loans altogether.
Policymakers seems to prefer finding these indirect ways of raising taxes, because these policymakers are politicians, too, and they understand that indirect taxes levied on businesses don’t look as obviously burdensome on ordinary, real people. The irony is that indirect taxes burden real people every bit as much as direct taxes on household incomes do, but the direction of the burden of an indirect tax is harder to control and tailor–because you are literally levying the tax on businesses based on business characteristics, and not on households based on household characteristics. So in the process of trying to make a tax look like a tax on an “evil corporation” and not a tax on middle-class households (or households with incomes below $250,000), just for example, you get a distribution of the tax burden that is nearly impossible to keep away from those very households you’re trying to avoid taxing–because you cannot exempt (protect) any households directly when you are not taxing any households directly.
This is in fact the problem with the excise tax on high-end health insurance plans levied on (evil?) insurance companies in the health reform bill. It is a tax limited to high-cost plans because policymakers intended it to look like a tax only on evil corporations but that would ultimately burden only rich households. But because it is tied to the characteristics of the health insurance plans the insurance companies sell, rather than the characteristics of the households who purchase such plans, it will inefficiently, unintentionally burden some lower-income households who purchase high-end insurance, while exempting from any burden many high-income households who do not purchase high-end insurance. In contrast, if the tax had been levied directly at the household level through the individual income tax, the tax could be tailored to more comprehensively apply to the employer-provided health plans of only higher-income households–or any subset of households policymakers feel comfortable burdening with the tax.
So that’s tonight’s public finance lesson on “tax incidence.” Tomorrow I hope to talk about taxes and “externalities” and the case of the BP oil spill (perhaps better labeled an “eruption”). Speaking of another potential “evil corporation”…
You go girl!
In my mind, the next step is arguing for tax simplification and directness.
Have a progressive income tax with no deductions. If your rate is 5% and you make $20,000, you pay $1,000.
I also think that we need to get rid of the corporate income tax and the estate tax and replace them with a “wealth” (intangible asset) tax similar to the property tax at the state and local levels. I think that it should also be progressive. If I have $5,000 and my rate is 1% then I pay $50. If Bill Gates has $50,000,000 and his rate is 2%, then he pays $1,000,000.
So you want to tax savings as opposed to consumption? Doesn’t sound like a particularly good idea to me but I agree with the first part of your proposal.
Mom:
Question. Since the tax is only levied on large banks, then how could they pass it on to their customers in a competitive market? If they tried, wouldn’t smaller banks (which are exempt from the tax) out-compete them?
And if the answer is that large banks can pass on the costs because they have market power, then don’t monopolistic/oligopolistic economic models predict that only half of the burden falls on the consumer? And shouldn’t that market power actually further the case for taxing large banks, in order to shrink them down?
I’m absolutely sold on the idea that it’s hard to decide where the incidence of taxes will fall. I do think you discourage behavior by taxing it, so if you tax something which you don’t want so much of, you will get less of it.
If the ’something’ is fossil fuel consumption, put a tax on it. If it’s financial churning, tax transactions. If it’s granite counter tops, cap the mortgage tax deduction. If it’s working, tax income. If it’s saving, follow John Bailey’s idea and tax wealth. Whatever you tax, you will discourage it relative to other activities. If you have a few taxes and they are very high, you will discourage those few taxed things.
I thought prices were determined by supply and demand. Are you saying that corporations, out of the goodness of their hearts, are artificially keeping prices lower than demand will support? If not, then why would they adjust to higher corporate taxes by raising costs for consumers rather than taking it out of profits, bonuses, etc.? This is the obvious counterargument to the claims you make. I’m not even an economist and it was obvious to me. But instead of addressing this point you rely on a bunch of straw man snarking, like putting “evil corporation” in quotes as if the only person who would disagree with you is some misguided kid in a Che T.
If you raise taxes on only one corporation, it cannot raise prices without losing market share. If you raise taxes on a corporation and all its competitors, price increases are guaranteed. Why? Because the taxes change the supply curve for that market.
The question of who ultimately pays corporate taxes has puzzled some very, very bright people for decades.
I thought prices were determined by supply and demand.
Of course prices are determined by supply and demand.
Are you saying that corporations, out of the goodness of their hearts, are artificially keeping prices lower than demand will support? If not, then why would they adjust to higher corporate taxes by raising costs for consumers rather than taking it out of profits, bonuses, etc.?
OK, what happens even in the case of the fantasy-of-the-left that the entire corporate tax come out of profits?
Well, obviously the return to the business’s investors drops. What happens when return on investment in a business drops? Investors leave it and it is more or less defunded. Hey, even left-wing “tax the rich”-ers want their pensions and IRAs invested to earn more, not less! So even they will insist on this.
Now, when a business is defunded, what happens to the supply it formerly produced? If that supply drops, what happens to consumer prices? Supply and demand in action!
OR, perhaps management will try to protect the business’s ROI to keep its investors by maintaining its after-tax return. In that case it will increase prices charged to consumers to increase pre-tax profit. This does necessarily require reducing supply produced (with marginal production, and employees, discontinued). Again, supply and demand in action!
OR maybe the tax cost will land on employees, or suppliers, or…
See, a *good* tax is “transparent” as to who pays it, so everybody knows who is paying what. It also is “equitable” in that persons in the same position pay the same tax.
But the corporate tax is horrible by these measures, about the very worst. Who actually pays it (incurs its “incidence”) — consumers, employees, suppliers, investors, etc. — varies in each case by the elasticity response of the different parties, so it is always different, and who the heck knows?
What that means in English is that, say, the new corporate tax lands on…
* A cigarette company. Cigarette consumers are addicts, hooked, their response is inelastic to price, they keep on buying no matter what. So the company passes the bulk of the tax right on through to them. And they pay. (Where I am in NYC cigs are $11 a pack thanks to taxes.) The tax lands on consumers.
* A call service company, which can get almost as good peformance from its workers if it outsources them to India, so its employment response is highly elastic. The business recoups the the cost of the tax by firing its employees and outsourcing. The tax lands on the now unemployed former employees.
It’s the same for suppliers, owners, everybody else related to the business. The incidence of the tax is divvied up among all of them in porportion to their elasticities. But who the heck can know how that works out without conducting a special study of the business?
All we know is that on a case-by-case basis the tax is totally opaque (bad!) as to whom it falls upon, and highly inequitable (bad!) in that it falls upon different parties in different businesses.
Of course, this very bad obscurity of the tax as to whom it falls upon is the great *virtue* of it politically, as it lets politicians pose as if the tax falls on nobody — and lets the political left indulge the happy fantasy that corporations will respond to being taxed “by taking it out of profits, bonuses, etc.”, instead of having the tax increase consumer prices, reduce employment, and reduce capital investment to make the country poorer in the long run.
This is the obvious counterargument to the claims you make. I’m not even an economist and it was obvious to me.
Well, it is obvious that you aren’t an economist.
Beyond that, maybe you should be more modest about arguments you make that you admit are based on your ignorance.
The question of who ultimately pays corporate taxes has puzzled some very, very bright people for decades.
The question of the incidence of taxation is interesting and often very complex even with simple taxes. Who really pays employment taxes that supposedly are 50% each employer/employee?
Who really pays sales taxes?
And remember, the *major* cost of taxation is not this tax shifting via the incidence, but the deadweight cost of taxes that reduces the economy outright.
For maybe the classic example of incidence and deadweight cost interacting, remember the 10% “luxury tax” on yachts and private airplanes that Bush I agreed to when breaking his “Read my lips, no new taxes” pledge.
Surely the rich can afford to pay 10% on their yachts and private planes!
Well, maybe they can. But as it happens, the demand for such luxury items is highly elastic. The rich immediately stopped buying them and spent their money on other toys.
So the rich paid zip, and the cost of the tax went right through to the firms making and selling yachts and planes, and to their employees who suffered mass layoffs, and their owners who went broke.
The net tax revenue resulting was *very negative* — costing the rest of us taxpayers everywhere — as the minor luxury tax collections were far more than offset by reduced business income and payroll taxes … plus, of course, surging cost of unemployment benefits.
By the time Congress revoked the tax a couple years later, these industries had suffered long-term structural damage. The firms couldn’t simply re-hire former employees — the firms had disappeared into bankrutpcy liquidation, their former employees had moved on, their industries’ capital was gone.
Everybody paid except the rich as the industries were hammered.
“Tax the rich!”
Jim, what’s your opinion on who ultimately pays the personal income tax? I figure that this is also job-dependent. For example, sole proprietors in service businesses like doctors or dentists or independent auto mechanics can raise their prices to offset higher income taxes. Does the provider pay the increased tax, or do his customers? It’s hard to say.
Anyone whose output faces international competition will have to absorb any increase in federal income tax. But for those with only local competition, increased tax burdens across the board would seem to result in increased prices across the board. Do you agree?
Now consider that a widespread tax increase will lead to widespread price increases on the service component of everything. The income tax increase has become, in part, a consumption tax increase. Is that a conventional view of things among economists?
Jim, what’s your opinion on who ultimately pays the personal income tax? I figure that this is also job-dependent…
The personal income tax really is a bunch of different taxes (on capital gains, AMT, etc.) imposed on persons in different situations (investors, owners of “pass through entities” like partnerships, self-employeds, employees, etc.) so it’s hard to say much without being more specific.
Again the principle is the tax falls on those in an “inelastic” position — who can’t act to escape it. As a simple example, say you…
* Really, really need your job. So if your boss cut your salary by $X you’d eat it and work on. If Uncle cuts your after-tax salary by $X through an income tax hike, you’ll eat that too. You’ll pay the tax, no choice.
* Have plenty of other options, but your boss really, really needs you. So if Uncle cuts your after-tax salary by $X through an income tax hike, you say: “Boss, you’d better increase my tax-free expense account by $X or I’m outta here”, and he does. Then your employer actually is paying the income tax nominally charged to you.
You can imagine how this works out with different taxes in different situations.
E.g., as to income tax on wages, studies show that if there are two earners in a family the “first” wage (needed to pay the rent and basic expenses) is inelastic and “eats it”, while the second wage is much more responsive to tax rate changes — the second earner will work more or fewer hours, change jobs, take a new one, quit working, etc.
Investors who want to shift money to avoid a tax increase can do so with a phone call or a mouse click, easy. For business owners and self-employeds it’s not that easy, but they have a lot more options than the worker who’s a family’s sole bread-winner.
So you can see how it depends on the specific type of tax and party being taxed.
Anyone whose output faces international competition will have to absorb any increase in federal income tax…
Yes, and this is especially important for corporations and their employees now that US corporate tax rates go up far higher than in most other countries.
As a recent CBO study of the corporate income tax found (via Lynne Kiesling on tax incidence)…
ISTM the answers to Lynne’s questions are obvious.