Working Paper: CEPR ID: DP17526
Authors: Arpad Abraham; Piero Gottardi; Joachim Hubmer; Lukas Mayr
Abstract: We revisit the classical result that in a closed economy the incidence of corporate taxes on labor is approximately zero. We consider a rich general equilibrium framework, where agents differ in the level of their wealth as well as in their managerial and working ability. Potential entrepreneurs go through all the key decisions affected by corporate tax changes: the choice of (i) occupation, (ii) organizational form, (iii) investment, and (iv) financing structure. We allow both for the presence of financial frictions and the traditional tax advantage of debt over corporate equity, which jointly generate misallocation of capital and talent. In this environment we characterize the effects of increasing corporate taxes both analytically and for a calibrated version of the model. We show that this tax increase reallocates production from C corporations to pass-through businesses. Since, due to distorted prices, the latter have higher capital-labor ratios, this reallocation generates a reduction in labor productivity and wages. Furthermore, the corporate tax increase induces some C corporations to reorganize as pass-throughs, which implies more restricted access to external funds and thus a socially inefficient downsizing of production in these firms. Finally, the tax increase causes further misallocation of talent by inducing agents with low wealth relative to their managerial talent to switch from entrepreneurship to being workers, while the reverse happens for agents with higher wealth and lower managerial skills. Overall, we find that both labor and capital bear a large share of the corporate tax incidence, while entrepreneurs are net beneficiaries of the tax change.
Keywords: Corporate Taxation; Tax Incidence; Heterogeneous Agents; General Equilibrium
JEL Codes: E62; G11; G32; H21; H22; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in corporate taxes (H29) | Reallocation of production from C corporations to passthrough businesses (H32) |
| Reallocation of production from C corporations to passthrough businesses (H32) | Reduction in labor productivity (J29) |
| Reallocation of production from C corporations to passthrough businesses (H32) | Reduction in wages (J31) |
| Increase in corporate taxes (H29) | Joint burden on capital and labor (E25) |
| Increase in corporate taxes (H29) | Lower production costs for passthroughs (H29) |
| Misallocation of talent (D29) | Switch from entrepreneurship to being workers for low wealth agents (L26) |
| Misallocation of talent (D29) | Switch to running passthroughs for high wealth agents (L85) |
| Increase in corporate taxes (H29) | Share of corporate tax incidence on labor (H22) |
| Increase in corporate taxes (H29) | Share of corporate tax incidence on capital (H22) |