Do state corporate income taxes reduce wages?

R. Alison Felix

Federal Reserve Bank of Kansas City Economic Review 94 (2009), 5-30

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 business 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 in 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.

High rates of corporate taxation reduce corporate investment and thereby depress local wages. Using cross-country data I estimate that a ten percentage point increase in the corporate tax rate of high-income countries reduces mean annual gross wages by seven percent. The results do not support the common belief that the burden of corporate tax falls most heavily on skilled labor; corporate taxation appears to reduce the wages of low-skill and high-skill workers to the same degree. The incidence of the corporate tax in the form of reduced wages suggests that taxing labor instead of taxing corporations could be Pareto-improving.