Monday, January 22, 2018

The Republican Tax Reform: Part 5–Tax Incidence vs. Tax Labeling

Microeconomics is one of the most common courses taken on college campuses around the world. It has been for decades.

One of the main topics towards the middle of that is that who a tax is incident upon (who actually pays it) has a lot more to do with the elasticity’s of demand and supply than who is labeled as being taxed.

Unfortunately, in politics, this insight is only used selectively.

Most people have no trouble recognizing that smokers are going to bear some of the burden of a tax on cigarette manufacturers. Politicians like it when that connection is recognized.

But when it comes to last year’s debates about the corporate income tax,† the incidence has been conveniently forgotten. Obviously, a lot of that has to do with grandstanding.

Even so, economists have even caved in the face of this moral hazard. There’s been a lot of calling out of Democratic-oriented economists over the past few months for finding reasons to object to the Republican plan (more on that in later posts).

Here’s a simple way to think about it. I’m envisioning this like a hull hypothesis in statistics: it’s not necessarily the truth, but it’s a good starting point for pinning down what the truth might be.

I start with the observation that national income and product accounts for all developed nations shows that compensation for peoples’ time is roughly 2/3 of GDP. Everywhere. All the time.

Now think of the revenue of the corporation, and note that it must equal costs plus profits. Since GDP is comprehensive, two thirds of that revenue is attributable to labor, as is 2/3 of costs, and 2/3 of profits. There might be small variations in that, but the bottom line (no pun intended) is it simply isn’t possible to attribute labor to one without attributing to the other too. The world just doesn’t split along lines that fine.

This means that if we cut a tax rate targeted at corporate profits, about 2/3 of the benefits of that are going to work back to the labor that helped produce the profit.

Reasonable people might quibble about how much that gets bumped up or down by the particulars of any particular tax bill, but the starting point for discussion by anyone should be that the corporate income tax is primarily incident on labor. It’s a sad testament that this should be a no-brainer.


So, I think the Democrats have a problem on this one. I don’t think I’m alone in the perception that many Democratically-oriented people would assert that the incidence of the corporate income tax on labor is zero. That’s possible, but exceptionally unlikely, to the point of being inconceivable once you start to think about how production works and is measured in GDP.

I also think a lot of Democrats would assert that Republicans are in favor of the reducing the corporate income tax because 100% of the benefits will go to the owners who are more likely to vote Republican. I may have missed it, but I don’t recall any Republican ever making a claim that bald. If anything, they seem to be saying fairly consistently that a big chunk of the benefits of a  corporate income tax cut will go to workers. For that, they get pilloried as favoring “trickle down”. For my part, 2/3 doesn’t sound like anything that trickles; it sounds more like those big buckets at water parks that dump all the water at once on the squealing kiddies beneath.

I think ya’ score one for the Republicans on this one. Of course, that goes some way towards explaining why the Democrats of a few years back were in favor of cutting the corporate income tax when it seemed more likely that they’d be the ones getting credit for it.

† The income that is taxed in by a corporate income tax is the net income on the income statement, commonly thought of as profits.

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