The Corporate Income Tax: An Entrepreneurial Perspective1
Filoso, Valerio, Quarterly Journal of Austrian Economics
ABSTRACT: While corporate income taxation is a major issue in the debate over international finance, economic theory has no clear stance on who bears its burden. On balance, economists seem still more prone to accept that taxing profits does not affect corporations' outcomes. This paper makes three cases for non-neutrality. First, since corporate income taxation is asymmetric between profit and loss, the tax rate may change the ranking of alternative investments. Secondly, the imperfect observability of the use of internal resources makes pure economic profits very difficult to detect. Thirdly, when the pervasive role of entrepreneurship is fully taken into account, corporate income taxation appears clearly as a direct tax on market adjustments and successful speculation.
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In 2007, top marginal corporate income tax rates among the member countries of the European Union ranged from a low of 10 percent (Bulgaria and Cyprus) to a high of 38.36 percent (Germany), with Italy closely following with a rate of 37.25 percent. In the world list of top corporate taxing countries, Japan scores first with a rate of 40.7 percent, followed by US and Germany, with the average level of corporate taxes in the EU declining from 38 percent in 1993 to 24.2 percent in 2007 (KPMG, 2007). This trend toward decrease,3 which is not limited to the EU, is mainly due to the competition between countries to attract and keep foreign investment: as of 2007, Moldova has set to zero the tax rate on corporate income.4 With regard to the US, in 2007 corporate tax revenues represented approximately 14 percent of federal government revenues,5 or 3.9 percent of gross domestic product. The total value of the corporate income tax amounted to $53,378,874.
Corporate income taxes are levied on the net income earned by corporate firms, i.e., on profit. Since profit is calculated sub tracting the sum of all costs from the sum of all revenues, it is not clear what effect this tax exerts on a firm's factor and product markets. Which stakeholders does the tax impact more heavily? Workers? Stockholders? Customers? It comes as no surprise that economic literature has not delivered any neat result about who pays corporate taxes, yet. In the standard textbook exposition, the incidence of this kind of taxes is rarely explored in detail and the most common result reported is that taxing profits does not change the production choices, independently of market structure. In the stream of more technically oriented literature, Krzyzaniak and Musgrave (1963) maintain that corporate taxation can be shifted backward or forward, due to market structure. Using a competitive general equilibrium model, Harberger (1962) proves that the tax is fully passed backward to capital owners. Feldstein, Green, and Sheshinski (1979) demonstrate that backward shifting is impossible in the case of a perfectly elastic capital supply. The implications of corporate taxation for the allocation of financial resources are somewhat clearer. In the effort to reduce their tax obligations, corporations generally are induced to use debt rather than equity finance, for interest payments to bondholders are deductible from taxable income, while dividend payments to corporate shareholders are not: in this perspective, Auerbach (2005) provides evidence that this substitution results in significantly higher debt/equity ratios. Furthermore, distributed dividends are often taxed twice: the first time as net income produced by the firm, the second time as part of personal income.
The aim of this paper is to show that the case for corporate tax neutrality does not hold as a general rule. To prove this result, section 2 reviews the traditional neoclassical model used to demonstrate that corporate taxes do not impact a firm's decisions. This result holds true only to a very limited extent, since it ignores risk and alternative investment choices. …