Do State Corporate Income Taxes Reduce Wages?

By Felix, R. Alison | Economic Review (Kansas City, MO), Spring 2009 | Go to article overview

Do State Corporate Income Taxes Reduce Wages?


Felix, R. Alison, Economic Review (Kansas City, MO)


Amid falling revenues and impending budget shortfalls, state policymakers must find ways to increase revenue, cut spending, or both. At the same time, they must develop policies that attract or keep businesses and jobs. Some policymakers may consider raising corporate tax rates because it avoids directly taxing workers who are already suffering the effects of this recession. But as states reevaluate their current tax policy, it is important to consider the effects of each tax component. One important question is: Who will bear the burden of the taxes?

State corporate income taxes are complex, and thus the answer to this question is far from obvious. Many believe that the state corporate tax structure is highly progressive because the corporate capital taxed is owned disproportionately by wealthy individuals. In today's economy, however, the burden of the corporate tax may have shifted to consumers or labor, resulting in a less progressive tax structure.

Research has shown that in some cases labor bears a substantial weight of the corporate tax. While this burden has fluctuated over time, the relationship between corporate taxes and wages has been consistently negative. In other words, higher corporate taxes are typically associated with lower wages.

This article examines the impact of state corporate taxes on wages. The first section of the article discusses the evolution of the state corporate tax. The second section explores who bears the burden of the tax. The third section uses empirical analysis to show that corporate taxes reduce wages and that the magnitude of the negative relationship between the taxes and wages has increased over the past 30 years. The analysis also finds that state corporate taxes have a larger negative effect on more highly educated workers.

I. HOW DO STATES TAX CORPORATIONS?

State corporate taxes were designed in the first half of the 20th century. The objectives of those early forms of the tax continue to influence current state corporate tax policy and its structure. But today's corporate tax programs continue to evolve, and their complexity makes it difficult to evaluate the impact of corporate income taxes.

The evolution of state corporate taxes

Taxing income had been tried several times in the New World, starting with the Massachusetts Bay Colony in 1643. But no income tax was able to generate a substantial amount of revenue until 1911, when Wisconsin became the first state to levy a successful corporate income tax (Stark). (1) The goal of Wisconsin policymakers was to distribute the tax burden more justly. At the time, the property tax was the main tax revenue source for states. Personal property was often difficult to assess, however, and much property escaped taxation. In addition, many high-salaried workers did not own much property, and many believed these workers were not paying their fair share of taxes. The corporate and individual income taxes sought to alleviate these problems (Kinsman).

The success of Wisconsin's income tax soon led other states to adopt similar taxes. By 1930, 23 states had adopted a corporate income tax, and within ten years 40 states were taxing corporate income (Brunori and Cordes). Today, Nevada, Wyoming, and Washington are the only states that do not tax corporate income. (2)

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Over the past 40 years, states' reliance on corporate tax revenue has varied (Chart 1). Overall, the share of total state tax revenues coming from the corporate tax peaked in 1980 at almost 10 percent. By 2002, the corporate tax share of total tax revenues had fallen to less than 5 percent, a decline largely driven by competition among states vying for new businesses. The viability and importance of the state corporate tax seemed to be permanently declining. But during the last five years, the magnitude of the state corporate tax revenue has increased.

Structure of state corporate taxes today

On average, corporate tax revenues make up about 7 percent of total state tax revenues. …

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Do State Corporate Income Taxes Reduce Wages?
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