The Budget reforms to corporation tax have prompted fresh debate on the old
question: is business paying its fair share of the tax burden? But while the
debate may be fiercely argued, the underlying question is fundamentally
Business may be responsible for making tax payments to HM Revenue &
Customs, but only individuals can bear the burden. So when corporation tax rises
or falls, we need to think about which sorts of individuals will win or lose.
Three sets of individuals may be affected by corporation tax: the owners of
the company may receive a lower net rate of return; the company’s customers may
pay a higher price; and those who sell goods and services to the company may be
paid a lower price. This last group includes the employees of the company, who
sell it their labour.
Economic theory has something to say on which of these groups is likely to
bear the tax burden. Since investors, both at home and abroad, can shift their
capital to another location, they will not accept an after-tax rate of return in
one country that is lower than the return they could earn elsewhere.
That means that a rise in the tax on capital located in any particular
country must ultimately result in a higher pre-tax rate of return on investment
there, leaving the post-tax rate of return unaffected. This means that investors
would not bear the burden of the tax. So who does?
A recent research paper presented at a conference of the European Tax Policy
Forum and the Institute for Fiscal Studies uses data on 23,000 companies from
ten European countries to investigate the impact of corporation taxes on wages.
The results are striking. The empirical evidence supports economic theory:
shareholders do not bear corporation tax – workers do.
In fact, the results show that in the long run wages fall by even more than
the tax payment. Raising the tax rate has two effects. First, the tax is passed
on in lower wages. Second, capital flows out of the country in response to a
higher tax. This raises the pre-tax rate of return on the remaining capital, but
leads to a fall in labour productivity and hence a fall in wages. These two
effects both fall on employees.
In principle at least, it is possible to design a corporation tax that would
be borne by shareholders rather than workers – a tax based on economic rent
specific to a particular country would be an example. Whether that can be
achieved in practice is another matter.
Michael Devereux is director of the Oxford University
Centre for Business Taxation and research director of the European Tax Policy
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