Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Francis Ball distinguished professor of economics in the Miller College of Business at Ball State University. His column appears in Indiana newspapers.
Among the most malunderstood concepts in public policy is the economic incidence, or burden of taxes. One unfortunate result is a good bit of bitterness and calumny over the subject of who pays their fair share of taxes. A bit better understanding is in order.
Taxes are collected through an administrative process. Property taxes are assessed against property owners, income and payroll taxes against income earners, inheritance taxes against heirs and sales taxes against consumers. However, the actual economic incidence of these taxes is only modestly influenced by the administrative process. In other words, it is the laws of economics, not government rules, that determine who bears the burden of taxation.
Corporate taxes provide a clear example. A corporation presumably pays taxes on its net income, so the naive among us suppose that those greedy stockholders pay the taxes. But, corporations can choose how much labor and machinery and land and raw materials to purchase. They have to pay market prices for all these items; so, to pay the corporate taxes, a company will change the number of workers or machines it buys. In this way, the burden of corporate taxes are shared among workers, investors, consumers and suppliers.
Payroll taxes offer another obvious example. When FDR pushed through social security, he did so in part by arguing that both the business and the worker would pay the tax. That is true administratively, but in fact workers bear the burden to a varying degree depending on how important they are to the business. Low skilled workers, who earn little, will pay all the tax in the form of lost earnings. Higher skilled workers, who command a higher wage and enjoy bargaining power, bear a lower share of the tax because they can force higher wage concessions on employers.
The relative share of tax paid by each group depends upon the relative responsiveness of each to a change in the prices they charge. Determining who pays occupies a fair bit of scholarly research, but it would take a different tax rate on every transaction to make it uniform. Moreover, because we consume and earn differently across our lifetimes, the share of income and wealth we pay in taxes depends in part on our age and whether we are businesses or households.
My goal in this column is not to sell anyone on a particular set of tax policies. I merely wish to point out that a government cannot simply change a tax law and dodge the laws of economics. Who we tax has little to do with the burden of taxation. How we tax can adjust the burden of payment. The best way to evaluate fairness in tax reform proposals is to spend some time understanding who is actually bearing the burden of the taxes. The answer may be very surprising.
Any tax debate we have should be influenced by data and analysis. The incidence, or burden of taxation is the least understood, and probably most important part of the debate.