Steadfast FinancesTax Incidence: What It Is and Why It Matters

Tax Incidence: What It Is and Why It Matters

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Did you know that you might be paying corporate taxes and not even know it? Don’t bother checking your 1040 for an accounting error. If you aren’t self-employed, but paying corporate tax rates, you are never going to know for sure thanks to something known as tax incidence.

Tax incidence is a term used in government to define the party who pays the financial burden of a given policy. Just because a piece of legislation outlines a tax or fee to one entity doesn’t mean that the identified entity bears the brunt of the legislation. Taxable entities and individuals often have the ability to shift legislative burdens to others, which means it’s important for policymakers to understand where the buck stops before crafting legislation that has unintended consequences.

Workers Pay Corporate Taxes, Not Corporations

Let’s go back to my introduction and talk about corporate taxes. There are many economists that believe that workers pay corporate taxes and not corporations. The argument is that taxes are considered a business expense, which means businesses need to find a way to come up with money to pay those expenses. They could raise prices on consumers and this does happen sometimes, but often it means less money for expansion or smaller payrolls. In recent decades with the massive popularity of outsourcing, foreign nations often legislate low tax rates as a way to entice corporations to move operations overseas and boost international employment.

Tax Incidence Also Works for Tax Incentives

Bruce Bartlett had an interesting article in the NY Times today. He was looking to see if there was a correlation in lower payroll taxes and employment.

It has long been argued by economists on the right that lowering employment and corporate taxes lowers the costs of employment to companies and will ultimately increase hiring. However, Bruce Bartlett pointed out that workers have seen record low taxes in the last few years, so shouldn’t there also be record employment?

The big question: if record low taxes haven’t boosted employment, then who is benefiting from tax breaks? Is it shareholders? Is it management?

The Role of Political Narrative

The trouble with economics is that it is very useful, but also very useless. While we are certain that tax incidence exists, the problem with the concept of incidence is that the outcome of policy is often open to political narrative. Is it that tax cuts don’t increase employment as Bruce Bartlett penned? My personal guess (and it’s definitely a guess, I haven’t looked at any research or data) is that tax breaks are helping to subsidize the rising burdens of employer health care costs.

As health care costs continue to outpace economic growth, it is becoming more expensive to employ workers. So when a tax cut comes along to reduce employment costs, increasing health care costs eat up the benefit.

You see how easy it is to come up with an economic explanation for why tax cuts haven’t boosted employment? The scary thing is I could be right and not even know it!

Still, the issue of incidence is a bit disturbing. Who knows what political party’s policies are coming out of your paycheck?

Shaun is the author of the blog Smart Family Finance, a site dedicated to exploring the challenges of family finance; from starting a marriage to starting a family, from teaching your children about finance to helping them pick a college, from single income to multiple income. The intricate world of family finance unlocked, one post at a time.

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Posted by CJ   @   3 May 2012 0 comments
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