Who Feels the Effects of Corporate Tax Change?

Many states have enacted corporate tax cuts in recent years in an attempt to maintain competitive business climates, relative to other states across the country. Policymakers introduce corporate tax cuts in the hope that businesses will relocate into their jurisdiction, thus decreasing the firm’s tax burden and growing the state economy. The theory behind this method is that corporations are indifferent across space when making their location decision, and reduced costs elsewhere will incentivize them to relocate into a cheaper area. And if true, immobile workers would bear the full burden of relocation and taxation as businesses leave high tax locations. However, previous research has suggested that these policy changes do not have strong effects on firm entry and exit into states.

In a recent paper from the National Bureau of Economic Research, Juan Carlos Suárez Serrato and Owen Zidar investigate the incidence of state corporate taxation by incorporating a new model, in which firms prefer to be located in specific locations for reasons not related to taxation. This assumption supports the idea that a firm is willing to incur a cost to remain in its current location. The willingness to incur these costs may stem from firms or industries being more productive in preferred locations, as well as being located in an area with a higher level of human capital or a more talented workforce. By not being perfectly mobile, Serrato and Zidar find that firms bear roughly 40 percent of the corporate income tax burden.

The authors use many economic indicators to investigate the short-run dynamics and long-run effects of changes in the corporate tax rules of states. This research entails gathering data on wages, housing costs, and tax changes at the smallest geographic data units available. Through this approach, they build a spatial equilibrium model that assumes different types of firms with different preferences about where to locate. Spatial equilibrium allows for local housing market characteristics, worker decisions, and firm decisions to determine final outcomes in labor and housing markets.

Using this model, Serrato and Zidar calculate the interrelation between wages, tax cuts, and land markets. They find that a one percent cut in business taxes increases establishment growth by three to four percent over a ten-year period. They also find that a one percent cut in business taxes increases wages by about 1.4 percent and profits by almost one percent over a ten-year period. This also increases rental costs by 1.2 percent, which somewhat undermines the wage gains.

Through the interaction of these three factors, the authors calculate the incidence of a corporate tax increase on these three market actors. They find that firms bear roughly 40 percent of the corporate income tax burden, while landowners bear approximately 25 to 30 percent and workers bear 30 to 35 percent of the corporate tax burden. The authors calculate the relationships between these spatial factors in order to determine a revenue-maximizing corporate tax rate for each state.

The conclusions of this study have many implications for policymaking at the state and local level. Previous theories in corporate income taxation placed the entire burden on workers who were left by a mobile firm avoiding high taxation. This model assumes heterogeneous effects and shows a shared burden of corporate taxation and shared benefit of corporate tax cuts. This suggests that states with high productivity or high firm attachment can enact comparatively high corporate taxation and not anticipate comparatively high firm departure.

Conversely, areas with lower productivity or firm attachment may not see comparatively high rates of firm entry after corporate tax cuts. Beyond firm mobility, this study provides policymakers with estimates of whom they are benefiting or hurting locally when they change the corporate tax burden. Workers, firms, and landowners are all found to bear significant burdens and benefits in corporate tax policy changes, and this research should provide guidance as to the welfare implications of policy changes.

 

Article Source: Who Benefits from State Corporate Tax Cuts? A Local Labor Markets Approach with Heterogeneous Firms, Juan Carlos Suárez Serrato and Owen Zidar, National Bureau of Economic Research, 2014.