Passing the burden: corporate tax incidence in open economies

1. Introduction

Corporate taxation has long been used in an attempt to increase the progressivity of the
tax structure and redistribute income, but as the economy becomes more open, the burden of
these taxes shifts from capital to labor, reducing their progressivity. Thus, taxing corporations
may create inefficiencies that do not produce the desired redistributive benefits. Reassessing the
incidence of corporate taxation in an open economy setting is necessary to aid policymakers’
decisions in designing tax policy that produces the desired revenue and redistributive properties
with the smallest possible deadweight loss.

It is well-known that those responsible for remitting taxes are not always those who bear
the burden of the tax. Early economic literature focuses on the incidence of taxes in a closed
economy, and Harberger (1962) estimates that capital, both corporate and non-corporate, bears
the entire burden of the corporate tax in a closed economy. He shows that this creates an
inefficient allocation of capital between the corporate and non-corporate sectors. Most corporate
capital is owned by the wealthy but some non-corporate capital is owned by the middle class,
and thus, corporate taxation was initially seen as a way to increase the progressivity of the tax
system even though the tax was slightly less progressive than originally believed.¹

As trade barriers were removed over time, volumes of trade and capital flows rose,
requiring a new look at the incidence of taxes-- one that focuses on the impact of openness.
Diamond and Mirrlees (1971) demonstrate that in a small open economy, any source-based
capital tax is inefficient. Their theory predicts that as the economy becomes open, capital
becomes more mobile, and thus the price of capital is fixed at the world return. Therefore, if a
country places a tax on capital, capital will flee to obtain the higher after-tax world rate of return.
Capital will continue to move abroad until the marginal productivity of capital at home is driven

<<   1   2   3   4   5   >>

More intriguing information