Hiking corporate taxes results in lower wages

Working people actually bear burden, writes Ken McKenzie

The lesson here is that reality can differ substantially from popular perception.

Who really pays corporate income taxes? This is an important policy issue — and was a central debate in the last provincial election. In a recent report published by The School of Public Policy we provide some answers.

It is important to understand two things when it comes to taxes.

First is that taxes rarely stick where they are first imposed. Rather, they tend to be “passed on” to other entities through the market system.

The second is that people, not corporate entities, ultimately bear the burden of corporate taxes. A key question is then, which people? The answer has important implications for the equity, or fairness, of the tax system.

There are three groups that could bear some of the burden of the corporate income tax (CIT): consumers through higher prices, labour through lower wages, and the owners of capital (shareholders) through lower returns.

The popular view is that rich investors or shareholders pay the CIT. The reality is different.

Theoretical simulation models suggest that in a small open economy, like Canada’s, where capital and goods are highly mobile between jurisdictions, while labour is less so, most of the burden of the CIT will fall on labour.

It works like this — an increase in the CIT lowers after-tax profits, which leads to a reduction in investment; this in turn reduces the capital to labour ratio, which lowers labour productivity, putting downward pressure on wages.

While interesting, the predictions of these simulation models should be viewed with caution, largely because of the sensitivity of the results to the underlying assumptions. A body of research has therefore emerged that goes directly to the data, and provides empirical estimates of the impact of corporate taxes on labour earnings.

While this research is relatively new, the evidence is mounting that corporate taxes are indeed borne to a significant extent by labour through lower wages. Much of this research is, however, based on data from other jurisdictions, such as the U.S. or Europe.

Ours is the first study to use Canadian data to examine the impact of provincial corporate taxes on wages.

Our results are consistent with the predictions of the models — that provincial corporate taxes do indeed adversely affect the capital to labour ratio which in turn lowers wages.

We estimate a 10 per cent increase in the CIT rate at the provincial level is associated with about a 1 per cent decrease in the real average hourly wage rate.

Using this estimate, we calculate that for every $1 in additional tax revenue generated by an increase in the provincial CIT rate, the associated long-run decrease in aggregate wages ranges from $1.52 for Alberta to $3.85 for Prince Edward Island.

Here’s what that means for Alberta, where CIT was recently increased — the 2 percentage point increase in the CIT rate in Alberta results in a decline in labour earnings for an average two-earner household of approximately $830 per year, which amounts to an annual reduction in aggregate labour earnings for the province of about $1.12 billion.

By way of comparison, other research has estimated the cost of the recently imposed carbon tax in Alberta to be approximately $525 per household.

Concerns about the distributional impact of the carbon tax on low and middle-income households prompted the government to provide a rebate of up to $420 per household. There is no rebate for the cost of reduced wages caused by a higher CIT.

The lesson here is that reality can differ substantially from popular perception, and that any government concerned with the fairness of its tax policy choices should carefully consider the impact of increasing corporate income taxes — they may not stick where you think.