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What Does the Corporate Income Tax Tax? A Simple Model Without Capital

  • Laurence J. Kotlikoff

    ()

    (Department of Economics, Boston University)

  • Jianjun Miao

    ()

    (Department of Economics, Boston University)

The economics workings of the corporate income tax remain controversial. Harberger?s seminal 1962 article viewed the tax as raising the cost of capital used to produce ?corporate goods.?But ?corporate goods?can be and generally are made by non-corporate ?rms, sug- gesting that the corporate tax penalizes the act of incorporating, not the decision of already incorporated ?rms to hire capital. This paper makes this point with a simple, capital-less model featuring entrepreneurs, with risky production technologies, deciding whether or not to go public. Doing so means selling shares, which is costly and triggers the ?rm?s classi- ?cation as a corporation subject to income taxation. But going public has an upside. It permits entrepreneurs to diversify their assets. In discouraging incorporation, the corporate tax taxes business risk-sharing, keeping more entrepreneurs private and, thus, exposed to more risk. The added risk experienced by these entrepreneurs limits their demands for labor whose costs must be paid come what may. And less demand for labor spells a lower wage. Thus, the corporate tax is, as a general rule, borne, in part, by labor. But it?s borne primarily by high-skilled entrepreneurs who decide to remain incorporated despite the attendant tax liability. While it hurts high-skilled entrepreneurs and low-skilled workers, the corporate tax ben- e?ts middle-skilled entrepreneurs who remain private, but are able, thanks to the tax, to hire labor at a lower cost. The reduction in labor costs has one other key e¤ect. It induces low-skilled entrepreneurs to set up their own risky businesses rather than work for others. This represents a second channel through which the corporate tax induces excessive buiness.

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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2010-013.

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Length: 20 pages
Date of creation: Jan 2010
Date of revision:
Handle: RePEc:bos:wpaper:wp2010-013
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  1. Bradford, David F., 1978. "Factor prices may be constant but factor returns are not," Economics Letters, Elsevier, vol. 1(3), pages 199-203.
  2. Jeffrey K. MacKie-Mason & Roger H. Gordon, 1991. "How Much Do Taxes Discourage Incorporation," NBER Working Papers 3781, National Bureau of Economic Research, Inc.
  3. Roger H. Gordon & Jeffrey K. MacKie-Mason, 1992. "Tax Distortions to the Choice of Organizational Form," NBER Working Papers 4227, National Bureau of Economic Research, Inc.
  4. Hui Chen & Jianjun Miao & Neng Wang, . "Entrepreneurial Finance and Non-diversifiable Risk," Boston University - Department of Economics - Working Papers Series wp2009-018, Boston University - Department of Economics.
  5. Kotlikoff, Laurence J. & Summers, Lawrence H., 1987. "Tax incidence," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 2, chapter 16, pages 1043-1092 Elsevier.
  6. Gravelle, Jane G & Kotlikoff, Laurence J, 1989. "The Incidence and Efficiency Costs of Corporate Taxation When Corporate and Noncorporate Firms Produce the Same Good," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 749-80, August.
  7. Kihlstrom, Richard E & Laffont, Jean-Jacques, 1979. "A General Equilibrium Entrepreneurial Theory of Firm Formation Based on Risk Aversion," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 719-48, August.
  8. Christophe Chamley, 1981. "Entrepreneurial Abilities and Liabilities in a Model of Self-Selection," Cowles Foundation Discussion Papers 580, Cowles Foundation for Research in Economics, Yale University.
  9. Arnold C. Harberger, 1962. "The Incidence of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 70, pages 215.
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