corporations may alter their business decisions in order to minimize their tax burden causing
further inefficiencies within individual corporations.
2.4 Tax Incidence across Skill-Level
If the burden of a corporate tax is expected to fall on labor, it is important to understand
the differential impact across skill. The principal mechanism by which labor bears the burden of
the corporate tax is via decreased marginal productivity of labor due to capital flight. By
determining how decreased capital differentially impacts labor productivity across skill, we can
understand its effect on wages. The elasticity of substitution between capital and labor plays a
key role in determining the impact of decreasing capital on wages. If the elasticity of substitution
between capital and labor and labor’s share of output is constant across skill, then any change in
capital should not differentially impact wages across skill.
Griliches (1969) estimates that capital is more complementary with skilled labor relative
to unskilled labor. This finding is known as the capital-skill complementarity hypothesis.
Bergstrom and Panas (1992) use 12 different models to show that this hypothesis holds in 92
percent of cases. If capital and skill are relatively more complementary, we should expect that
any change in capital will have the largest impact on skilled labor. In a small open economy,
theory tells us that the burden of a capital tax falls on labor because corporate taxation leads to a
decrease in capital in the home country. Combining this theory with the capital-skill
complementarity hypothesis, the burden of a corporate tax should be heaviest on high-skill labor
since lower levels of capital will have the largest negative effect on this group.
This result can also be seen in a model. To choose the appropriate production function, I
refer to a large body of economic literature estimating the elasticity of substitution between