_________________ 

A Review of the Evidence on the 
 

Incidence of the Corporate Income Tax 
 

by 
 

William M. Gentry 
 

Williams College 
 

OTA Paper 101 December 2007
 

OTA Papers is an occasional series of reports on the research, models, and datasets developed to 

inform and improve Treasury’s tax policy analysis. The papers are works in progress and subject 

to revision. Views and opinions expressed are those of the authors and do not necessarily 

represent official Treasury positions or policy. OTA Papers are distributed in order to document 

OTA analytic methods and data and invite discussion and suggestions for revision and 

improvement. Comments are welcome and should be directed to the author. 

Office of Tax Analysis 
 

US Department of the Treasury 
 

1500 Pennsylvania Avenue, NW

 Washington, DC 20220 
 

The author is grateful to Deena Ackerman, Bob Carroll, Mike Devereux, Don Kiefer, Jay 

Mackie, and Jim Poterba for helpful comments. Comments are welcome; please direct them to 

William.M.Gentry@williams.edu. The author served as a consultant to the Office of Tax 

Analysis during the time this paper was written. 

Department

OTA Papers

of the Treasury Assistant Secretary for Tax Policy Office of Tax Analysis
_________________ 

A Review of the Evidence on the 
 

Incidence of the Corporate Income Tax 
 

by 
 

William M. Gentry 
 

Williams College 
 

OTA Paper 101 December 2007
 


OTA Papers is an occasional series of reports on the research, models, and datasets developed to 

inform and improve Treasury’s tax policy analysis. The papers are works in progress and subject 

to revision. Views and opinions expressed are those of the authors and do not necessarily 

represent official Treasury positions or policy. OTA Papers are distributed in order to document 

OTA analytic methods and data and invite discussion and suggestions for revision and 

improvement. Comments are welcome and should be directed to the author. 

Office of Tax Analysis 
 

US Department of the Treasury 
 

1500 Pennsylvania Avenue, NW

 Washington, DC 20220 
 

The author is grateful to Deena Ackerman, Bob Carroll, Mike Devereux, Don Kiefer, Jay 

Mackie, and Jim Poterba for helpful comments. Comments are welcome; please direct them to 

William.M.Gentry@williams.edu. The author served as a consultant to the Office of Tax 

Analysis during the time this paper was written. 

1 
A Review of the Evidence on the Incidence of the Corporate Income Tax 

Abstract 

Who ultimately bears the burden of the corporate income tax plays an important role in 

the distributional analysis of tax policy. Distributional tables often assume that the incidence of 

the corporate income tax falls on the owners of capital but there is considerable uncertainty 

amongst economists about who bears the burden of the corporate income tax. This paper 

reviews the evidence on the incidence of the corporate income tax, especially in light of recent 

empirical studies that focus on the relationship between the corporate income tax and wages. 

While further research is necessary to draw definitive conclusions, these studies suggest that 

labor may bear a substantial burden from the corporate income tax. These empirical results are 

consistent with computable general equilibrium models based on an open economy in which a 

single country sets its tax policy independently of other countries; in these models, assumptions 

that capital is mobile and consumers are willing to substitute tradable goods produced in 

different countries imply that labor can bear more of the incidence of the corporate tax than 

capital bears. Evidence on the degree of capital mobility across countries and the sensitivity of 

corporate investment to changes in tax policy also corroborate the possibility that the corporate 

income tax lowers wages by reducing the productivity of the work force. In addition to changes 

in productivity associated with changes in capital intensity, labor may also bear part of the 

corporate income tax if wages are determined in a bargaining framework since the corporate 

income tax may change the equilibrium wage bargain. Overall, the recent empirical evidence, 

the open economy computable general equilibrium models of tax incidence, and the sensitivity of 

the amount of capital investment within a country suggest reconsidering the assumption that the 

corporate income tax falls on the owners of capital; labor may bear a substantial portion of the 

burden from the corporate income tax. 

William M. Gentry 

Department of Economics 

Williams College 

Williamstown, MA 01267 

(413) 597-4257 

William.M.Gentry@williams.edu 

2 
A Review of the Evidence on the Incidence of the Corporate Income Tax 

I. Introduction 

Determining the incidence of the corporate income tax – that is, who actually bears the 

burden of taxing corporate income – is of central importance in the debate over tax reform. The 

corporate tax could be borne by some combination of the shareholders of corporations, investors 

in all capital through a decrease in the overall return to capital, workers through a decrease in 

wages, and customers through increased output prices. Depending on how this tax burden plays 

out in equilibrium, the corporate tax can either increase or decrease the progressivity of the tax 

system. Furthermore, given the possibility that the corporate income tax creates a variety of 

distortions, the economic burden of the tax exceeds the amount of revenue raised by the tax; the 

total distributional effect of the tax needs to account for this excess burden as well as the 

revenues collected by the tax. 

The actual burden of the corporate income tax depends on a complicated set of behavioral 

reactions to the tax. The tax can change incentives for investment in the corporate sector, how 

these investments are financed, and the location of investment across countries; in addition, the 

corporate tax may favor some types of corporate investment over others. In turn, these 

investment decisions can affect output prices by changing the cost of production and can affect 

wages by altering how much capital firms use. Given the complicated nature of these changes, it 

is not surprising that the incidence of the corporate income tax remains controversial among 

economists. The complicated nature of these interactions has pushed applied research on 

corporate tax incidence towards relying on general equilibrium models to inform the policy 

debate. As discussed below, the conclusions from these models depend heavily on the 

assumptions made in constructing the model. Until recently, empirical evidence on the incidence 
 

 

of the corporate income tax has been scarce. A nascent literature has developed that uses 

international data on corporate taxes and wages to estimate empirically the burden of the 

corporate income tax. 

In this paper, I review this new empirical evidence on the corporate income tax. A 

common conclusion of these empirical studies is that labor seems to bear a substantial burden 

from the corporate income tax. This conclusion is in stark contrast to common assumptions used 

in distributional analyses of the US tax system that often allocate the corporate tax to the owners 

of capital.1

 As a way of determining the plausibility of these results, I examine the empirical 

evidence on the magnitudes of the critical responses in investment to changes in tax policy that 

must underpin the conclusion that labor bears the burden of the corporate income tax. 

In addition to reviewing the empirical evidence, I place this evidence in the context of the 

general equilibrium models that have been the workhorses for predicting the incidence of the 

corporate income tax. These models have yielded a wide variety of conclusions about the 

incidence of the corporate income tax – ranging from capital bearing the burden of the corporate 

income tax to labor bearing the burden of the tax. One of the critical assumptions for these 

models is the choice between modeling a closed economy, so that capital does not flow between 

countries, and an open economy, in which international capital flows are central to determining 

the incidence of the corporate income tax. In the closed economy case, models often find that 

capital bears most or all of the corporate tax since the overall rate of return to capital falls as 

capital moves from the corporate to non-corporate sectors. Such models often assume that the 

effects of the corporate tax on the overall size of the capital stock are relatively modest since the 

1

 Distributional analyses of the US tax system use a variety of assumptions about the incidence of the corporate 

income tax. See Barthold, Nunns, and Toder (1995) for a (somewhat dated) review of the assumptions used at 

various government agencies. While some reports include distributional tables that allocate a portion of the 

incidence of the corporate income tax to labor, the most common assumptions involve allocating the burden of the 

corporate tax (without adjusting for its excess burden) to owners of capital. 

2 
savings (and, hence, capital formation in a closed economy) does not respond strongly to the 

return to saving. In contrast, many open economy models predict that labor will bear the burden 

of the corporate tax under the assumption that capital is more mobile across countries than labor. 

As Harberger (1995) points out, while the open economy assumption has considerable 

appeal as capital markets become more integrated, whether one should think in terms of the 

closed economy or open economy model also depends on whether all countries simultaneously 

change tax policy or a single country acts independently of other countries. If all countries 

simultaneously change their corporate income tax rates in a coordinated fashion, then the closed 

economy that focuses on the response of the total capital stock to the return to saving may be 

more appropriate than the open economy model that focuses on capital moving across borders. 

In contrast, if one wants to consider the effects of a single country changing its corporate tax rate 

holding other countries policies as fixed, then capital mobility across countries plays an 

important role in the analysis. Thus, the incidence of the corporate tax may depend heavily on 

the specifics of the proposed policy change and how other countries will respond to the policy 

change. 

While general equilibrium models have been mainstays in analyzing the incidence of the 

corporate income tax, both Auerbach’s (2006) recent review of the incidence of the corporate 

income tax and the empirical results of Arulampalam, Devereux, and Maffini (2007, discussed 

below) suggest that forces that are difficult to capture in such models may play an important role 

in determining who bears the tax. Specifically, Auerbach provides a number of reasons why 

shareholders may bear the burden of the tax without passing the tax to all capital owners, 

especially in the short term. One such mechanism is that the corporate tax falls, in part, on 

economic profits. However, Arulampalam, Devereux, and Maffini’s empirical results focus on 

3 
the possibility that wage bargaining provides a mechanism by which shareholders can shift some 

of the tax onto employees, even when a portion of the tax base is economic profit. 

This review proceeds as follows. Section II reviews the recent empirical evidence on the 

effects of corporate income taxes on wages and the empirical challenges to measuring the 

incidence of the corporate income tax. Section III puts this evidence in the context of general 

equilibrium models and highlights behavioral responses that would be consistent with this 

evidence. Section IV discusses evidence on these various behavioral responses, including the 

responsiveness of corporate investment to tax policy and international capital mobility. The last 

section concludes with the implications of this evidence for setting corporate tax policy. 

II. New Evidence on the Incidence of the Corporate Income Tax 

A naïve view of the incidence of the corporate tax is that shareholders bear the burden of 

the tax through lower after-tax rates of return. This naïve view ignores the possibility that the tax 

will be shifted onto consumers through higher prices, workers through lower wages (possibly 

due to a fall in capital accumulation), or other types of capital as capital shifts out of the 

corporate sector in response to the lower after-tax return offered by corporations. To move 

beyond this naïve view, a model of economic behavior is necessary to guide predictions about 

how the burden of the corporate income tax will be distributed. Much of the literature on 

corporate tax incidence has focused on building such models and, depending on the assumptions, 

these models have generated a wide range of predictions. 

Given the wide-range of possible burdens generated by taxing corporate income, the true 

incidence of the corporate income tax is an empirical question. Empirical work on this question 

faces a number of difficult challenges. First, at least if one focuses on a single country, there has 

4 
been relatively little variation in corporate tax rates over time. While there has been more 

variation in tax rates across types of investment and across firms, such variation is problematic 

for testing general equilibrium tax effects since a part of this variation in tax rates is endogenous 

to firms’ investment decisions. Second, a natural candidate for the dependent variable in a study 

of tax incidence is the rate of return to capital but disentangling the tax effects on rates of return 

from other determinants of rates of return (e.g., risk) is difficult. Separating the short-run tax 

incidence effects on rates of return, which might be captured more easily with data, from the 

long-run tax incidence effects, which are often the objects of theoretical models, further 

complicates empirical work on the effects of the corporate income tax on rates of return. 

A trio of recent papers – Arulampalam, Devereux, and Maffini (2007); Hassett and 

Mathur (2006); and Felix (2007) – present new evidence on the incidence of the corporate 

income tax based on the relationship between cross-country variation in corporate taxation and 

wages. While corporate tax rates change infrequently within a single country, many countries 

have had major corporate tax reforms over the last 25 years. These papers exploit these tax 

reforms to measure the effects of corporate taxation. Instead of trying to measure how corporate 

taxes affect rates of return, these papers concentrate on whether corporate taxes reduce wages. 

By focusing on wages instead of rates of return to capital, these studies avoid some of the 

measurement issues associated with measuring rates of return as well as some of the short-run 

capitalization effects that can be conflated in estimating the effect of the corporate income tax on 

the rate of return to capital. 

Despite many methodological differences across the studies (discussed in more detail 

below), the papers all conclude that labor bears a substantial burden of the corporate tax. 

Consider the following conclusions from the studies: 

5 
 

Our central estimate is that 61% of any additional [corporate] tax is passed on 

in lower wages in the short run and around 100% in the long run. 

(Arulampalam, Devereux, and Maffini, abstract) 

Using cross-country panel data from the Luxembourg Income Study, I 

estimate that a ten percentage point increase in the corporate tax rate decreases 

annual gross wages by seven percent. Using U.S. data on corporate tax 

revenues and total wages, these estimates predict that labor’s burden is more 

than four times the magnitude of the corporate tax revenue collected in the 

U.S. (Felix, p. 3) 

The results in this paper suggest that corporate tax rates affect wage levels 

across countries. Higher corporate taxes lead to lower wages. A 1 percent 

increase in corporate tax rates is associated with nearly a 1 percent drop in 

wage rates. (Hassett and Mathur, p. 25) 

Given the recentness of these papers, below I briefly review their results. Given the use of crosscountry variation in tax rates used by these papers, they are mainly working in the spirit of open 

economy tax incidence: what happens within a country when it changes its tax policy without 

consideration of the tax policies of other countries? 

II.A. Firm-level Estimates of Wage Effects 

Arulampalam, Devereux, and Maffini (henceforth, ADM) emphasize two potential 

channels for corporate taxes to affect employee compensation. First, the standard corporate tax 

incidence story that taxes affect firms’ decisions about using capital and labor. The firm-specific 

changes in factor demands can affect wages even though workers have an outside wage option 

that does not necessarily depend on the corporate tax system. Second, to the extent that firms 

earn economic rents (in addition to just a competitive rate of return), workers and firms may 

engage in bargaining over these rents. The corporate tax liability can change the outcome of this 

bargaining. 

6 
ADM estimate the magnitude of this second effect of the corporate tax. Thus, their 

empirical approach does not capture the general equilibrium effects created by shifts in capital 

intensity. They use firm-level data on 15,433 firms from four European countries (France, Italy, 

Spain, and the UK) from the period 1993-2003. The dependent variable in their analysis is the 

logarithm of employee compensation per worker. They measure corporate tax burdens as the 

logarithm of the firm-level corporate tax liability per worker; this tax variable measures the 

amount of tax paid by the firm rather than a corporate tax rate. In addition to taxes, their 

empirical specification allows for compensation to depend on lagged compensation, value-added 

per worker, and year fixed effects. The inclusion of value-added per worker leads to their 

interpreting their results as arising from the bargaining channel; if the corporate tax leads to shifts 

in capital intensities, then these effects will be captured by the inclusion of the value-added per 

worker variable since changes in capital intensity will affect worker productivity and value-added 

per worker. The broader general equilibrium effects of the corporate tax would have additional 

effects on wages, returns to capital, and output prices. 

Due to issues of endogeneity of the tax and value-added variables and persistence in the 

lagged dependent variable, ADM use several years of lagged data as instruments; the use of 

lagged variables as instruments reduces the useful time period over which they estimate their 

model to the last four years of the sample period. The ADM empirical model exploits variation 

in effective tax rates (i.e., tax liability relative to profit) across firms and over time. Since the 

effective tax rate is endogenous to profits and wages, they use lagged tax variables as well as 

country-specific measures of statutory tax rates and effective marginal and average tax rates as 

instruments. Thus, while they measure corporate taxes using corporate taxes per worker, they 

instrument for this tax measure using a variety of measures of the corporate tax rate. 

7 
 

Despite the challenges created by the persistence of firm-level wage data and the potential 

for endogeneity between taxes, profits, and wages, ADM find a statistically significant negative 

effect of corporate taxes on wages: a higher corporate tax liability reduces average worker 

compensation. In their baseline specification, they find a short-run elasticity of employee 

compensation with respect to corporate taxes per worker of -0.072. This elasticity is equivalent 

to a $1 in corporate tax liability reduces average compensation by $0.61 in the short run and 

around $1 in the long run. As an alternative specification, ADM replace the value-added per 

worker with the capital-labor ratio and a separate variable for the number of employees. In this 

specification, the corporate tax can have two effects on compensation: (1) the bargaining effect 

that is captured by the elasticity with respect to taxes per worker; and (2) an indirect effect by 

changing the capital-labor ratio. In this specification, the bargaining effect is about two-fifths 

smaller with an estimated elasticity of -0.042 (though only statistically significant at the 90% 

confidence level) and compensation is increasing in the capital-labor ratio with an elasticity of 

0.220.2 

As a test of whether bargaining could underlie this tax shifting result, ADM test whether 

firms that are part of a multinational group are able to shift more of the tax than purely domestic 

firms. The underlying hypothesis is that multinational operations may increase the firms’ 

bargaining power. ADM find evidence consistent with this hypothesis: the elasticity of 

compensation with respect to corporate taxes is roughly twice as large for multinational firms as 

for purely domestic firms. 

2

 To deduce the portion of the estimated effect of the capital-labor ratio on compensation that is due to taxes, one 

needs to know how responsive capital investment is to corporate taxation. Estimating precise relationships between 

taxes and investment typically requires substantially more data (in terms of variation in tax laws either over time or 

over place) than ADM have (see the investment studies discussed below). Nonetheless, ADM report results from a 

reduced-form specification that replaces the capital-labor ratio with the effective marginal tax rate. The effect of the 

effective marginal tax rate is negative (as expected) but quite imprecisely estimated and the elasticity of 

compensation with respect to taxes per employee falls to -0.027 and is not statistically significant. 

8 
 

 

II.B. Effects on Household Wage Earnings 

Felix (2007) approaches the question of the effect of corporate income taxes on annual 

labor earnings using quite different data than ADM. Her earnings data, taken from the 

Luxembourg Income Study, are from household surveys from 19 developed countries over the 

period 1979 – 2002.3

 For each year and country in her data, she measures annual labor earnings 

for low-, middle-, and high-skill workers (where education captures skill). Thus, she has three 

observations for each country-year in her data where the dependent variable is the logarithm of 

the annual gross wage for each skill-level. The main measure of the corporate tax rate is the top 

statutory tax rate; since this measure does not capture investment incentives such as depreciation 

allowances, the average tax rate (based on the experience of US multinational corporations 

operating in the country) provides an alternative measure of the extent of corporate income 

taxation. The empirical specification also includes the degree of openness of the economy 

(measured as the value of trade) and allows for an interaction between the effect of corporate 

taxes on labor earnings and how open the economy is.4 

Felix’s analysis yields three main results. First, the corporate income tax rate (measured 

either with the marginal tax rate or the average tax rate) has a negative effect on labor earnings. 

In specifications that do not interact the corporate tax rate with the openness of the economy, the 

estimated effect of a one percentage point increase in the corporate tax rate is a -0.50 to -0.70 

percent decrease in annual gross wages (the range depends on what other control variables are 

included) but the estimated effects are not statistically significant. In specifications that include 

3

 Data are not available for each country in each year. Given the data requirements for the study, it uses data from
 


65 country-year combinations. 
 4

 As control variables, the specification also includes workforce characteristics (education, age, and gender), 
 

personal income tax rates, GDP per capita, and random country-level effects. 
 

9 
 

 

interactions with the degree of openness, the estimated effect of a one percentage point increase 

in the corporate tax (evaluated at the mean level of openness) is a -0.71 to -1.23 percent decrease 

in the annual gross wage.5

 In discussing the magnitude of this effect, assuming that the effect of 

the tax rate on annual wages is -0.90 percent, Felix calculates that a one percentage point increase 

in the average US corporate tax rate would reduce aggregate wage earnings by roughly 4.2 times 

the additional corporate income tax revenue collected. While an effect of this magnitude seems 

quite large, it is consistent with the corporate tax creating considerable amounts of economic 

distortion in addition to the revenue collected. 

Second, contrary to the hypothesis that highly-skilled labor will bear more of the 

corporate income tax than less-skilled labor due to complementarities between skill and capital, 

the negative effect of the corporate tax on earnings is quite uniform across skill groups. Thus, the 

model does not offer support to the possibility that the negative effects on wage income will 

accrue mainly to higher-wage workers. 

Third, as expected, a greater degree of openness has a negative effect on earnings; 

however, the interaction term between the level of corporate taxes and openness generates 

somewhat puzzling results. A standard theoretical claim is that labor will bear more of the 

corporate tax in an open economy than a closed economy so one might expect a negative 

interaction between openness and the level of taxation. Felix estimates a positive coefficient on 

the interaction term when using the marginal tax rate and little relationship when using the 

average tax rate. Felix suggests that openness might also increase opportunities for corporate tax 

avoidance so that the corporate taxes are less important in more open economies, consistent with 

the estimated results. 

5

 In specifications that use the average corporate tax rate instead of the marginal corporate tax rate, the estimated 

effect of a one percentage point increase in the corporate tax rate on the annual gross wage is -0.92 to -1.03 percent 

and statistically significant at the 99 percent confidence level. 

10 
 

II.C. Effects on Manufacturing Wage Rates 

Hassett and Mathur estimate the effect of corporate taxes using a broader sample of 72 

countries with data from 1981-2002. Relative to the other two studies, Hassett and Mathur 

include a broader array of countries including many developing countries. Their dependent 

variable is the logarithm of the average hourly wage rate in manufacturing; they average their 

dependent variable over five-year windows and use dependent variables from the beginning of 

the window to explain variation in wages. As control variables, they include value added per 

worker in the manufacturing sector, the overall price level, the personal income tax rate, year 

fixed effects and country fixed effects. They use several alternative measures of the corporate tax 

rate: (1) the top corporate marginal tax rate; (2) effective marginal corporate tax rates; and (3) 

effective average corporate tax rates. 

Across a wide variety of econometric specifications, Hassett and Mathur report a strong, 

negative effect of corporate taxes on wage rates but little effect of personal income taxes on wage 

rates. Thus, labor appears to bear a large portion of the corporate tax as well as the personal 

income tax on wage income. In specifications using the top corporate marginal tax rate, the 

elasticity of wage rates with respect to the corporate tax rate is roughly -1.0. In interpreting this 

result, Hassett and Mathur calculate that, setting all other variables to their average values, a onestandard deviation increase in corporate tax rates (i.e., an increase of ten percentage points from 

an average value of 35 percent) would reduce wages by 25 percent. This result seems 

exceptionally large. In alternative specifications using the effective marginal tax rate and the 

effective average tax rate, Hassett and Mathur reported estimated elasticities that are roughly half 

11 
as large (and somewhat less statistically significant) as when they use the top corporate marginal 

tax rate. Thus, the magnitude of the effect is quite sensitive to how the tax rate is measured. 

Given that ADM suggest that controlling for value added as a measure of productivity 

should make it difficult to estimate the effects of corporate taxes on wages that come through 

changes in capital intensity, one question about Hassett and Mathur’s results is whether they are 

sensitive to controlling for value added. To address this issue, Hassett and Mathur estimate a 

two-step procedure in which corporate taxes can affect the capital-labor ratio (the first stage) and 

the capital-labor ratio can affect the wage rate (the second stage). While Hassett and Mathur find 

support for this two-step process in determining wage rates, they do not report estimates of the 

magnitude of the overall effect of corporate taxes on wages based on the estimated coefficients 

from this two-stage model. 

Hassett and Mathur report two auxiliary results that suggest that international capital 

flows may play a substantial role in driving the results. First, in specifications that include wage 

rates and corporate tax rates in neighboring countries (defined either geographically or by income 

group), they estimate that both the wage rate and corporate tax rates of the neighboring countries 

have a positive effect on a country’s wage rate. One explanation for this result is that a country 

(and its workers) benefit from higher capital investment when its neighbors have either high 

wage rates or high corporate taxes. Second, the estimated effects of the corporate tax rate are 

stronger for smaller countries, which one would expect are more vulnerable to the effects of 

being open economies. 

Since Hassett and Mathur’s original work, several authors have based other work on their 

approach. Felix (2007) uses her data to estimate a specification that is similar to Hassett and 

Mathur’s main specification. Recall that her data focuses on developed countries and that the 

12 
 

 

wage information comes from household surveys instead of being collected from manufacturing 

firms. Her data have few country-year observations but do calculate wage rates for different skill 

levels. Using the top corporate tax rate as her measure of the tax rate, she estimates statistically 

significant elasticities of the hourly wage rate with respect to the corporate tax rate that are 

roughly half as large as those reported by Hassett and Mathur. 

Gravelle and Hungerford (2007) re-estimate the Hassett and Mathur specifications using 

alternative methods for adjusting wages for exchange rate differences. Hassett and Mathur 

convert wages for each country to US dollars using annual exchange rates; Gravelle and 

Hungerford point out that nominal exchange rates do not capture differences in the relative 

purchasing power within the two countries. Thus, they convert the wage variable to US dollars 

either with a Purchasing Power Parity (PPP) exchange rate or an inflation-adjusted PPP exchange 

rate. In specifications that use the top corporate tax rate as the dependent variable of interest, 

Gravelle and Hungerford report that these alternative exchange rate conversions reduce the 

estimated coefficient from -0.84 in Hassett and Mathur to -0.74 and -0.51, respectively, and the 

statistically significance falls to the 90% confidence level. Alternative measures for the tax rate 

lead to similar proportional declines in the estimated tax effects and the effects are no longer 

statistically significant. 

II.D. Consensus and Challenges 

On the whole, this trio of studies paints a consistent empirical picture of corporate tax 

incidence: labor bears a large burden from the tax, possibly exceeding the revenues collected 

from the tax.6

 The exact magnitude of the estimated effect and whether these studies are robust 

6

 In contrast to the consensus of these studies, an earlier empirical literature on the incidence of the corporate income 

tax failed to converge on a consensus. In the 1960s and early 1970s, several studies examined aggregate time series 

13 
 

 

 

 

to statistical challenges remains an open question. While all three papers use international data 

on corporate taxes and returns to labor and study a similar time period, their data sources and 

empirical methods differ substantially. 

Despite the consensus among the papers, a skeptic might raise several general issues with 

the results. First, for the most part, the papers seem to be capturing corporate tax incidence over 

a relatively short-run horizon. If, as argued by ADM, the corporate tax affects bargaining over 

profits, then this wage bargaining might take several years before reaching equilibrium, 

depending on labor market institutions. If the effects of the corporate tax on wages come through 

changes in capital investment, one might expect that these effects would occur over several 

years.7

 Thus, the papers estimate short-run effects that one would expect to be smaller than the 

long-run effects. However, the timing might work in a somewhat opposite direction as well. 

Goolsbee (2003) estimates that, in the short-run, investment subsidies (e.g., changes in corporate 

tax policy to encourage investment) raise the price of capital goods and the wages of workers in 

capital goods sectors. Thus, a reduction in corporate tax burdens could increase wages of firms 

that supply capital goods to other corporations; however, since the suppliers of capital goods are 

also corporations, this effect could induce a negative correlation between wages and the corporate 

data on rates of return and corporate taxes. Musgrave and Krzyzaniak (1963), Dusansky (1972), and Sebold (1979) 

find evidence of shifting (and possibly overshifting) of the corporate tax either onto consumers or workers; in 

contrast, Gordon (1967) and Oakland (1972) report that capital bears the short-run incidence of the corporate income 

tax. The contradictory nature of these results suggests caution in using long time-series data in estimating the effects 

of the corporate income tax. The lack of empirical consensus was one reason that computable general equilibrium 

models became the prevailing guides for analyzing the corporate income tax. Mulligan (2002, 2003, and 2004) 

revisits this approach using more recent empirical techniques based on Euler equations; his evidence is consistent 

with capital taxation being sshifted away from capital in the medium to long run.

7

 Presumably, the lag between changes in tax policy and the effect on the wage motivates Hassett and Mathur to 

examine the effect of the tax rate in a given year on average wages over the next five years. Gravelle and 

Hungerford (2007) report that Hassett and Mathur’s results are sensitive to the choice of timing between the 

calculation of the wage variable and the tax rate variable. In a specification that uses the annual wage (using their 

real PPP-adjusted wage rate) instead of the five-year annual wage, Gravelle and Hungerford include the 

contemporaneous tax rate as well as the five years worth of lagged variables for the tax rate. While all of the 

estimated tax rate coefficients are negative, none of them are individually statistically significant. It is unclear 

whether the tax rate variables are jointly statistically significant or how important the choice of exchange rate 

adjustment is for comparing this specification with those of Hassett and Mathur. 

14 
 

 

tax. These wages changes could be transitory effects on wages so that the short-run relationship 

between wages and corporate taxes overstates the long-term effect. 

Second, an important challenge for any empirical estimates of the response to taxes is to 

find exogenous changes in tax policy. To evaluate the long-term effects of policy, one needs data 

on permanent changes in policy and considerable amounts of data before and after these policy 

changes. Given the relatively modest time horizons in the papers and the relative infrequency of 

major corporate tax reforms, it is unclear whether the measured effects are capturing the long-run 

effects of tax policy.8

 Moreover, a common fear in econometric analysis is that the policy is 

endogenous to the variable of interest. For the relationship between wages and corporate taxes, 

this fear leads to the concern that governments shift towards higher capital taxation just before 

the returns to labor fall. Instead of the causality flowing from corporate taxes to wages, lower 

predicted wages induce higher capital taxation. 

Third, the magnitudes of the results seem quite large based on a priori expectations about 

corporate tax incidence. In many specifications across the three papers, modest shifts in 

corporate tax policy lead to substantial changes in labor income. As will be discussed below, 

some theoretical models would support effects of the magnitudes reported but many 

parameterizations of theoretical models suggest the estimated effects are implausibly large. 

Nonetheless, the evidence suggests rethinking the common assumption that capital bears all of 

the corporate income tax seems warranted. Even if the true effect of how much of the corporate 

tax is borne by labor is smaller than most of the point estimates suggest, labor could bear a 

substantial burden from the corporate tax. The controversial nature of the results suggests that 

future empirical work building on these studies is necessary before drawing definitive 

8

 Since ADM focus on firm-level variation in effective tax rates, their estimates are not susceptible to the criticism 

that tax policy is endogenous. 

15 
 

conclusions. Obviously, a sample of three studies is small for a meta-analysis of the issue; 

however, given the differences in approach across the three papers, it is intriguing that each paper 

finds large effects of the corporate tax on wages. 

III. Theoretical Context for New Empirical Estimates of Corporate Tax Incidence 

A natural question to ask is what theoretical model is consistent with the possibility that 

labor bears a substantial burden from the corporate income tax. This section proceeds in two 

parts. The first provides an overview of the results of a standard general equilibrium model; the 

second considers extensions to this model and other theoretical concerns. 

III.A. Basic General Equilibrium Modeling Framework 

Given the standard differences in the analysis of closed and open economies, the result is 

much more consistent with an open economy model. In an open economy, the corporate tax can 

cause a reallocation of capital across countries as well as across domestic sectors. If capital is 

mobile (and labor is immobile) across jurisdictions, then labor’s share of the tax burden can be 

high. 

A quantitative theoretical prediction for the allocation of the burden of corporate taxes 

requires building a specific model of the international economy. The task of building such a 

model is outside the scope of this review. Fortunately, recent papers by Randolph (2006), 

Harberger (2006), and Gravelle and Smetters (2006) carefully present general equilibrium 

analyses of the long-run impacts of the corporate income tax.9 To fix ideas, consider Randolph’s 

model of corporate tax incidence in an open economy. The model has two countries, each with 

9

 The analyses in these papers build several earlier papers, including Bradford (1978), Harberger (1995), Melvin 

(1982), and Mutti and Grubert (1985). 

16 
 

five sectors and three factors of production (capital, labor and land). Of the five sectors, three 

sectors face the corporate tax: (1) a sector that produces tradable goods that are perfect substitutes 

with foreign goods; (2) a sector that produces tradable goods that are imperfect substitutes with 

the foreign goods; and (3) a non-tradable sector. The remaining two sectors are noncorporate 

with one producing tradable goods and the other producing non-tradable goods. All five sectors 

in both countries have production functions with constant returns to scale and markets are 

assumed to be perfectly competitive. 

In general equilibrium models, predictions depend critically on assumptions about factor 

mobility and the variability of factor supplies. Randolph starts with the traditional assumption 

that capital is perfectly mobile across sectors within a country and across countries. Labor is 

mobile across sectors within a country but cannot move across jurisdictions. In the aggregate, 

capital is in fixed worldwide supply. Labor supply is in fixed supply within each country. These 

assumptions are critical since factor mobility, supply elasticities, and the relative capital 

intensities of different sectors drive the price changes that determine the burdens of the tax. One 

justification for assuming that factors are mobile is that the models are predicting the long-term 

effects of tax policy, rather than short-term effects. 

Randolph focuses on a model in which the US has a corporate tax and the foreign country 

does not. One can interpret the results as the incidence of the difference between the US 

corporate income tax rate and the foreign corporate tax rate. Moreover, the predictions of the 

model apply to a change in US tax policy holding the tax regimes in other countries as fixed so 

the main results of the paper ignore the possible effects of tax competition among countries or 

other forms of interdependency between countries’ corporate tax systems.10 An alternative 

10 Randolph discusses the interaction between increased capital mobility and tax competition over the last 25 years. 

Below, I discuss the implications of tax competition for corporate tax incidence. 

17 
 

 

 

assumption about differences in corporate tax rates across countries is that both countries levy the 

same corporate tax rate; under this assumption, the assumption of a fixed worldwide capital stock 

pushes Randolph’s model back towards the closed economy model in which capital bears the 

burden of the corporate income tax. 

Under reasonable assumptions about factor shares and elasticities, Randolph’s main 

results can be summarized as follows. First, domestic labor and capital bear the corporate tax 

roughly in proportion to their factor income shares in the economy; thus, labor bears roughly 

73% of the corporate income tax (compared to receiving 70% of overall income) and capital 

bears 33% of the corporate income tax (compared to receiving 29% of overall income).11 

Second, the domestic corporate income tax has important implications for factor returns in the 

foreign country; a higher US corporate tax rate increases wages and decreases returns to capital in 

the foreign country. Expressed as a percent of US corporate tax revenues, foreign labor gains an 

amount that is equal to 71% of the corporate tax revenues and foreign capital losses an amount 

equal to 72% of the corporate tax revenues. These effects come from the increase in capital 

investment in the foreign country. With more capital, foreign workers are more productive but 

the return to capital in the foreign country falls. 

In terms of domestic labor’s share of the corporate tax burden, these theoretical results 

seem fairly consistent with ADM’s results, despite ADM’s suggestion that wage bargaining 

rather than changes in capital intensities underlies their results. In contrast, they are smaller than 

the estimated effects of Felix or Hassett and Mathur. In comparing these theoretical results with 

the empirical results discussed above, one needs to keep in mind that the corporate tax can affect 

11 The corporate tax burdens on domestic capital and labor do not sum to 100% for several reasons. First, these 

burdens are expressed as percentages of corporate tax revenues; since the tax creates a deadweight loss, total 

burdens exceed total revenues. Second, land is a third factor in the model; domestic landowners actually benefit 

slightly from the corporate income tax (land is primarily an input in noncorporate production). Third, as discussed 

below, some of the burden of the tax is borne by foreign factors of production. 

18 
 

 

 

real income both by changing the returns to factor (e.g., the wage rate) and by changing the 

overall price level. Randolph measures effects as the total effect on the sources and uses of 

income (i.e., the net effect of changes in factor prices and output prices). While a higher 

corporate tax rate reduces wages, it also reduces overall consumer prices.12 In contrast, using a 

similar open economy, general equilibrium model, Harberger (1995) predicts that labor may bear 

a sources-side burden that is 2 to 21⁄2 times the size of corporate tax revenues. In subsequent 

work, Harberger (2006) reports overall effects that suggest that domestic labor bears 96% of the 

overall (i.e., sources and uses effects included) burden of the corporate income tax. Thus, the 

isolated effect on wage rates may overstate the true economic burden on labor. How do the 

empirical studies handle this distinction? Felix does not control for the price level effects of the 

corporate tax and compares her results to Harberger’s (1995) sources-side only model. Hassett 

and Mathur report that they obtain similar estimates regardless of whether they estimate a model 

of the nominal wage or the real wage. Since ADM use firm-level data, it is difficult for them to 

control for overall price level effects. Taken together, Randolph’s theoretical conclusions seem to 

lend support to the overall impression from the empirical analyses that labor bears a substantial 

burden from the corporate income tax. 

III.B. Extensions and Alternative Considerations 

Randolph’s conclusions are quite consistent with the standard intuitions about corporate 

tax incidence in an open economy with competitive markets. A natural question to ask is how 

12 The effect on the price level in the model is a statement about relative prices across sectors. Randolph assumes 

that the first sector in the corporate sector is the numeraire good. The non-traded corporate good is relatively 

capital-intensive so its price increases relative to the numeraire good. However, the relative prices in the noncorporate sector (other than agriculture which is assumed to have a fixed world output price) fall due to a reduction 

in both wages and the cost of capital in the non-corporate sector. 

19 
these conclusions depend on the basic assumptions in the model. This section considers some of 

the major extensions of the general equilibrium model of tax incidence. 

III.B.1. Imperfect Competition 

Imperfect competition can come in many forms with a variety of implications for who 

bears the corporate income tax. In an important precursor to Randolph’s work, Gravelle and 

Smetters (2006) highlight the importance of one particular form of imperfect competition: what 

happens to the basic open economy tax incidence prediction that domestic labor bears the 

corporate income tax when tradable goods are less than perfect substitutes across countries? As 

consumers are less willing to substitute between foreign and domestic goods, capital will become 

less responsive to tax differentials (even though there are no explicit restrictions on capital 

mobility). Firms will be able to raise output prices in response to an increase in capital taxation. 

Gravelle and Smetters conclude that “the open economy assumption does not automatically 

imply that domestic labor bears the long-run incidence of a corporate income tax even if capital is 

perfectly mobile (p. 4).” The incidence does not, however, automatically fall on domestic 

capital; instead, some of the burden may be exported to foreigners. 

While Gravelle and Smetters raise an interesting caveat to the standard open economy 

result, several issues need to be addressed before dismissing the possibility that labor bears a 

substantial burden from corporate taxation. First, the degree of substitutability of domestic and 

foreign goods is an empirical question. Based on estimates from bilateral trade equations 

presented by Erkel-Rousse and Mirza (2002), Randolph concludes that the long-run demand 

elasticities are likely to be quite large so the case of perfect substitutes may be quite reasonable. 

Second, the Gravelle and Smetters collapses all corporate tradable goods into a single composite 

20 
commodity and applies an overall elasticity; as they discuss, alternative model specifications that 

allow for multiple corporate sectors with varying degrees of substitutability across countries and 

varying capital intensities complicate the analysis (see also Harberger, 1995, and Randolph). A 

more detailed model with multiple corporate sectors can reduce the effect of imperfect 

substitutability between domestic and foreign goods can imply that domestic labor bears more of 

the corporate income tax. 

The imperfect competition that Gravelle and Smetters analyze is essentially a situation 

where each country has some market power, even though no firms have market power. Thus, 

they stay within the common general equilibrium modeling framework of perfectly competitive 

markets with constant returns to scale. This form of imperfect competition suggests that, even 

though capital can move across borders, capital will be less mobile than if foreign and domestic 

goods are perfect substitutes. Thus, Gravelle and Smetters argue that factors that influence the 

aggregate amount of capital (i.e., how saving responds to changes in the after-tax rate of return to 

capital) play a role in determining the incidence of the corporate tax even when capital is freely 

mobile across countries. 

Of course, imperfect competition comes in many other forms, such as technologies that 

lead to oligopolistic industries or firms having control over scarce inputs (such as intangible 

capital). These forms of imperfect competition create challenges for general equilibrium 

modeling since the general equilibrium effects focus on the effects on the marginal rate of return 

but imperfect competition implies that some of the tax revenues come from taxing inframarginal 

sources of return. In his review of corporate tax incidence, Auerbach (2006) discusses the 

implications of these sorts of imperfect competition for corporate tax incidence. Not surprisingly, 

the implications depend on the specifics of what generates economic rent. Pure monopoly is a 

21 
 

 

classic textbook case in which the portion of the corporate income tax that is a tax on pure 

monopoly profit cannot be shifted away from the owners of the monopoly. Other cases of 

imperfect competition provide much more ambiguous results.13 A difficulty with drawing 

general conclusions about corporate tax incidence based on models of imperfect competition is 

that the degree of imperfection competition and the sources of deviations from perfect 

competition vary across industries in the economy. 

The importance of considering the tax burden on economic rents increases when one 

considers the interaction between the tax system and firms’ financing decisions. Typically, 

general equilibrium models consider the corporate tax as the difference between the tax rate on 

using capital in the corporate sector and the tax rate on using capital in the noncorporate sector. 

As emphasized by Stigliz (1973), to the extent that debt is the marginal source of financing for 

corporations and interest payments are tax deductible, the return to marginal investments by the 

corporation may not face the corporate tax.14 However, inframarginal returns (e.g., from the 

returns to intangible capital that cannot be financed by borrowing) will still face the corporate tax 

and the usual general equilibrium mechanisms for shifting the corporate tax may not be relevant. 

On the whole, as summarized by Auerbach, a common sentiment is that the presence of economic 

rents combined with endogenous financing choices makes it more likely that capital (and 

especially shareholders of corporations as opposed to owners of all capital) bears the corporate 

tax. 

13 Davidson and Martin (1985) imbed a game-theoretic model of imperfect competition in a general equilibrium 

model of corporate tax incidence; depending on the relative capital intensity of the sector with imperfect 

competition, capital can bear more or less than 100% of a tax on capital even when capital is in fixed supply. 

14 Auerbach and Hassett (2003) examine the marginal source of finance for US corporations. For many companies, 

their results suggest that retained earnings and new equity are the marginal source of finance; however, they report 

considerable heterogeneity in the marginal source of finance. 

22 
 

 

The underpinnings of ADM’s empirical work suggest an important caveat to this claim 

that shareholders cannot shift the corporate tax. They focus on the possibility that wages are 

determined through bargaining between the firm and workers. Thus, wages are not merely 

determined by the marginal product of labor, as is assumed by the general equilibrium models. 

By changing the amount of money over which firms and workers bargain, the corporate tax can 

affect the incomes of workers even if it does not change the amount of capital used by the firm or 

the output prices charged by the firm. 

III.B.2. Labor Mobility 

Randolph’s open economy general equilibrium model makes the typical assumption that 

capital moves across borders but labor stays in the same location. Unsurprisingly, such a model 

results in the less mobile factor bearing the burden of interjurisdictional differences in taxation of 

the mobile factor. Naturally, as one increases the mobility of labor, one would expect that it 

becomes less likely that a tax on mobile capital will be shifted onto labor. 

For the federal-level corporate tax in the U.S., this assumption seems quite natural since 

migration flows are relatively modest.15 However, since the empirical evidence discussed above 

relies on a wide range of countries, the assumption of immobile labor may not be the best 

assumption with which to interpret their results. Specifically, Felix relies fairly heavily on 

differences in corporate tax rates across European countries, which tend to have more 

opportunities for cross-border migration than U.S. labor markets. Furthermore, recall that 

Hassett and Mathur find evidence that high corporate tax rates in neighboring countries are 

15 In contrast, if one were interested in the tax incidence of state-level taxes within the United States, assuming that 

labor is immobile would probably be unpalatable. Consistent with labor mobility affecting wages, Feldstein and 

Wrobel (1998) find that wages respond to interstate differences in taxation (albeit personal taxes rather than 

corporate taxes). 

23 
associated with higher wages in a country, consistent with mobility being the mediating force 

between tax rates and wages. Given the differences in labor mobility between the countries used 

in these studies and the U.S., it seems unlikely that a U.S.-specific result would suggest that labor 

bears less of the corporate tax than implied by the studies. 

In addition to the possibility that labor moves in response to changes in factor prices, tax 

incidence can also depend on whether labor supply within a country varies due to changes in 

wage rates. The variation in labor supply could arise from changes in labor force participation 

decisions (including retirement decisions), hours worked conditional on being in the labor force, 

or changes in human capital (which can affect the effective amount of labor generated by a given 

number of hours worked). 

III.B.3. Variable Factor Supply and Endogenous Savings 

Randolph’s general equilibrium model also follows the tradition of assuming fixed total 

factor supplies. Of course, the total amount of labor and capital can depend on tax policy. 

Allowing for variable factor supply (both labor and capital) moves us from what Kotlikoff and 

Summers (1987) refer to as static models of tax incidence, in which overall factor supplies are 

fixed, to dynamic models of tax incidence, in which factor supplies are endogenous. These 

models tend to focus on the long-run incidence of tax policy. However, as discussed by 

Auerbach (2006), these dynamic effects can affect tax incidence in the transition from one longrun equilibrium to another. 

Fully accounting for endogenous labor supply and capital investment in a model of tax 

incidence is a daunting task since it requires specifying intertemporal choices of both savings and 

labor supply. One interaction to keep in mind is that the assumption of an open economy reduces 

24 
 

the link between savings decisions and investment decisions within a country. With perfectly 

mobile capital and perfect substitutability between foreign and domestic goods, the capital stock 

and the eventual return to capital in a given country does not depend on the saving decisions of 

the residents of that country. Capital mobility breaks the link between savings and investment 

within a country. 

If capital is less than fully mobile or other conditions conspire to keep capital from 

flowing too readily in response to tax differences (e.g., Gravelle and Smetters’ model of traded 

goods being imperfect substitutes), then the savings response to differences in the rate of return 

will affect the capital stock within a country. Savings within a country will partially determine 

investment within the country. The magnitude of this savings response depends on households’ 

intertemporal elasticity of substitution. Unfortunately, economic theory does not make an 

unambiguous prediction on the sign or magnitude of the relationship between saving and the 

return to saving. Thus, the relationship between savings and the after-tax rate of return is an 

empirical question. 

Empirical work on the relationship between rates of return and saving has been 

inconclusive.16 One of the challenges for empirical work has been to identify exogenous 

variation in the after-tax rate of return. For example, the level of savings and the return to saving 

may be jointly determined by macroeconomic factors. Similarly, how a tax-induced change in 

the after-tax rate of return affects savings may depend on whether the change in tax policy holds 

overall fiscal policy (e.g., the government budget deficit) constant or not. In thinking about 

corporate tax incidence, the natural starting point is what economists refer to as balanced-budget 

tax incidence. Any change in tax revenue from altering the corporate tax rate would be offset by 

other tax changes. This thought experiment eliminates effects on the capital stock that come 

16 For a survey of this research, see Bernheim (2002). 

25 
 

 

from government borrowing. Hence, the critical issue is the relationship between the rate of 

return and private saving. 

To the extent that capital bears the burden of the corporate income tax, a higher corporate 

tax rate leads to a lower after-tax rate of return to capital. If private savings is positively related 

to the rate of return, then the savings response to a higher tax rate will lead to lower savings and 

lower domestic investment (taken as given that international capital flows are insufficient to 

eliminate the relationship between domestic saving and investment). The long-run implication 

for the incidence of the corporate income tax is that a higher tax rate leads to a lower domestic 

capital stock which leads to lower productivity and wages for workers. While there is uncertainty 

over the magnitude of these effects, it is unlikely that endogenous capital formation will reduce 

the burden of the corporate income tax borne by workers and it may substantially increase the 

burden on workers. 

III.B.4. Tax Competition 

The standard general equilibrium model of tax incidence assumes a tax rate differential 

between the corporate and non-corporate sectors within a country and, in the case of open 

economy models, a corporate tax rate differential between countries. The possibility of tax 

competition means that these tax rate differentials are not created in a policy vacuum. One 

country’s tax policy can respond to the tax rates set by other countries. Tax competition raises 

the specter of a race to the bottom such that taxes on mobile factors cannot survive in an open 

17 economy. 

17 For a comprehensive overview of international tax competition and its interactions with capital mobility, see 

Fuest, Huber and Mintz (2005). 

26 
 

Building a general equilibrium model that accounts for tax competition requires modeling 

how tax policy in one country responds to changes in tax policy in other countries. This naturally 

leads to considering strategic interactions among governments. If governments act in an 

uncoordinated fashion, one might conclude that capital income taxes will not survive in an open 

economy with relatively small countries (see, e.g., Gordon, 1992). The possible negative 

consequences of tax competition suggest that governments may want to foster institutions that 

will help coordinate tax policies across countries. 

The policy implications of tax competition depend on whether a government thinks that 

its change in tax policy will induce other countries to change their tax policies. For example, a 

high-tax country reducing its tax rate to the average tax rate of other countries might engender a 

different response than a country with an average tax rate aggressively lowering its tax rate. For 

corporate tax incidence, the size of the tax policy response of other countries will determine 

whether capital actually flows across borders in response to a tax change. For example, if the US 

reduces its corporate tax rate and other countries do not change their tax rates, then the US is 

likely to attract more capital (so that labor will benefit from higher wages); in contrast, if the 

other countries respond to a US tax cut by cutting their tax rates, then the capital inflows might be 

relatively modest. 

IV. Corroborating Empirical Evidence 

The empirical papers surveyed above suggest that labor bears a substantial burden from 

the corporate tax and this shifting may occur even in the short run. The general equilibrium 

models also suggest that labor can bear a considerable burden from corporate taxation. The 

extensions to the general equilibrium model considered in the previous section do not refute the 

27 
 

possibility that labor bears much of the corporate tax. Another way of addressing the validity of 

the empirical results described above is whether other empirical regularities are consistent with 

the observed relationship between corporate taxes and wages. In this section, I focus on the 

empirical evidence along three margins. First, how mobile is capital across countries? 

Specifically, is the location of capital sensitive to differences in tax rates across jurisdictions? 

Second, how sensitive is corporate investment to tax policy? Third, does capital migrate across 

organizational forms in response to tax differentials? 

IV.A. How Mobile is Capital across Countries? 

Open economy models of tax incidence rely on the assumption that capital is mobile 

across countries so that investment in a country can respond to tax policy induced changes in the 

rate of return even if domestic savings does not respond. With mobile capital, capital can escape 

the burden of the tax. Two types of evidence are relevant for evaluating this assumption: (1) 

macroeconomic studies of the fluidity of capital markets; and (2) specific evidence on 

international capital flows in response to tax differentials. 

The degree to which capital is mobile across countries remains a contentious issue in 

international economics. Part of this debate arises due to their being multiple definitions for 

“capital mobility” (see Frankel, 1992). On the one hand, capital mobility can be defined based on 

whether capital flows are strong enough to equalize real rates of return (controlling for exchange 

rate changes) from investing in different countries. Obstfeld’s (1995) review of the capital 

mobility literature suggests that international capital markets work fairly well at eliminating 

arbitrage opportunities across financial markets in different developed economies. On the other 

hand, capital mobility can be measured based on relationships between domestic saving rates and 

28 
investment rates. Feldstein and Horioka (1980) argue that high capital mobility should lead to a 

low correlation between saving and investment within a country; however, their empirical work 

suggests that the correlation is relatively high – a result that has been labeled the FeldsteinHorioka puzzle. Similar to the puzzle of high correlation between domestic saving and domestic 

investment, a number of papers have documented “home bias” in the portfolio investments of 

investors in different countries (see, e.g., French and Poterba, 1991, and Tesar and Werner, 

1995). 

The Feldstein-Horioka puzzle has generated extensive subsequent research, both in terms 

of econometric methods and challenges to the validity of the approach as a measure of capital 

mobility; Obstfeld (1996) provides a review of these issues through the mid-1990s. Furthermore, 

over the last 25 years, international capital markets may have become more integrated as 

countries have reduced capital controls (see Edwards, 1999). Several recent papers, including 

Blanchard and Giavazzi (2002) and Coakley, Fuertes, and Spagnolo (2004) argue that recent data 

suggests that the Feldstein-Horioka puzzle is disappearing, especially in the context of the 

European Union. Thus, the different measures of capital mobility may be converging on the 

conclusion that capital is mobile across countries. 

Turning to the evidence on capital mobility responses to differences in tax policy, Desai, 

Foley, and Hines (2004) summarize the sizable literature on the responsiveness of foreign direct 

investment (FDI) to host country corporate tax rates as generating an elasticity of FDI with 

respect to after-tax returns of roughly -0.6; both time-series and cross-sectional econometric 

techniques produce similar estimates of this elasticity. Consistent with this consensus view, 

using a sample of US multinational firms, Desai, Foley and Hines estimate a similar elasticity of 

FDI with respect to the host country corporate tax rate; they also find that foreign affiliates’ 

29 
 

 

 

 

capital-labor intensities depend on the level of the corporate income tax in the host country.18 

Moreover, other host country taxes (such as indirect taxes) also influence FDI. These tax effects 

arise despite the tax planning opportunities that US multinational firms can use to minimize their 

taxes without resorting to altering capital investment decisions. 

While there is some controversy regarding the interpretation and continuing existence of 

the Feldstein-Horioka puzzle, in general, the evidence suggests that capital is quite mobile across 

countries. Covered interest parity tends to hold across countries suggesting little need for 

increased capital flows as a way of eliminating arbitrage opportunities. Corporate investment 

decisions appear quite sensitive to international differences in after-tax rates of return. Thus, the 

empirical evidence supports the open economy assumption for modeling the incidence of the 

corporate income tax. 

IV.B. How Strong is the Relationship between Investment and Corporate Taxation? 

One channel through which the burden of a tax on capital can be shifted to labor is 

through changes in the amount of capital. Thus, in considering whether it is plausible that labor 

bears a substantial fraction of the burden of the corporate income tax, it is natural to ask whether 

capital taxation affects the level of capital investment. Fortunately, the relationship between 

capital taxation and investment has been studied extensively. 

Hassett and Hubbard (2002) survey both the theoretical relationship between taxation and 

business investment and the existing empirical research. The basic theoretical model related 

investment to the tax-adjusted user cost of capital. This user cost of capital can depend on the 

18 While it is tempting to interpret the evidence on the responsiveness of US multinational’s FDI to host country tax 

rates as evidence of a substitution of foreign investment for domestic investment, Desai, Foley, and Hines (2005) 

find that, for a sample of US multinational corporations, domestic and foreign investments are complements rather 

than substitutes. Thus, one should use caution in inferring that the sensitivity of FDI to foreign tax rates 

immediately translates into a reduction in the US capital stock and an increase in the foreign capital stock. 

30 
corporate tax rate but also depends on other aspects of tax policy, such as the generosity of 

depreciation allowances. 

Through the mid-1990s, this empirical research could be characterized as suggesting that 

tax policy has relatively little effect on corporate investment. More generally, the early research 

on capital investment suggested that the entire neoclassical model of investment theory does not 

provide a compelling explanation of the data. The econometric problem has been to find 

exogenous variation in tax incentives for investment so that incentive effects can be separated 

from other influences on investment (e.g., the business cycle). More recent research, however, 

has overcome some of these econometric challenges and concludes that corporate investment is 

sensitive to tax policy. The empirical sensitivity of investment to the user cost of capital is 

typically measured as the estimated coefficient on Tobin’s Q. Using data on U.S. corporations, 

Cummins, Hassett, and Hubbard reported estimated coefficients on Q of roughly 0.65. Other 

studies using U.S. data (see, e.g., Chirinko, Fazzari, and Meyer, 1999) report somewhat smaller 

sensitivities of investment to tax policy but their estimates are still statistically and economically 

different than zero. 

Since the empirical studies of the effects of corporate taxes on wages focused on non-U.S. 

data, it is instructive to consider empirical studies on the relationship between tax policy and 

investment based on data from a similar set of countries. Cummins, Hassett, and Hubbard (1996) 

repeats the exercise of their early paper but uses data from 14 industrialized countries; the 

international data suggest a significant relationship between investment and tax policy in most 

countries, though the magnitude is typically (though not always) smaller than the estimated 

elasticity for the U.S. Using a sample of 85 countries, including both developed and developing 

countries, Djankov et al. (2007) examine the effect of corporate taxes on investment; rather than 

31 
 

examine firm-level data using a user cost of capital model, they test whether investment-to-GDP 

ratios depend on the effective tax rate on investment. They report substantial negative effects of 

tax rates on investment rates: increasing the corporate tax rate by 10 percentage points leads to an 

investment rate that is 2.2 percentage points lower (compared to an average investment rate of 

21.5%); much of the effect appears to come through a reduction in FDI. 

Overall, a consensus seems to be emerging that investment responds to tax policy. The 

amount of capital in the corporate sector depends on the taxation of capital. This relationship is 

what one would expect to find if capital is able to move out of the corporate sector in response to 

tax policy and, as a result, labor may bear a sizable portion of the corporate tax. 

IV.C. Does Activity Shift between Corporate and Noncorporate Forms of Organization? 

An alternative channel through which the corporate income tax can affect the amount of 

capital in the corporate sector is how capital is allocated across organizational forms. In the 

classic formulation of the Harberger model, the noncorporate sector produces different goods 

(e.g., housing) than the corporate sector. Reallocating capital across sectors meant changing the 

mix of outputs in the economy; this shift in output could affect the overall return to capital and 

labor. The substitutability of capital for labor in the two sectors will affect the eventual incidence 

of the corporate income tax. 

In a pair of papers, Gravelle and Kotlikoff (1989 and 1993) build general equilibrium 

models in which corporate and noncorporate forms operate within the same industry. The 

corporate and noncorporate firms differ along one of two dimensions: (1) in the mutual 

production model, they differ in that corporate managers run corporations but entrepreneurs 

operate noncorporate firms and entrepreneurial skill is distributed throughout the economy; or (2) 

32 
 

in the differentiated products model, the outputs of the types of firms are not perfect substitutes. 

In the first model, a tax on corporate capital can be good for entrepreneurs in the noncorporate 

sector since their talent becomes a more scarce resource; however, the gains of the entrepreneurs 

are not necessarily gains for workers in general and the model suggests that workers can lose 

from a corporate tax even when capital appears to bear 100% of the tax burden. With 

differentiated products across types of firms, the incidence depends on the degree to which 

consumers are willing to substitute goods and the relative elasticities of substitution of capital for 

labor in production.19 

While these models illustrate the importance of considering endogenous organizational 

form from a theoretical perspective, one might also ask whether capital seems to be mobile across 

organizational forms. If so, then one would expect that this mobility would reduce the expected 

burden borne by capital from the corporate income tax. This mobility may suggest that the 

economic burdens of the corporate income tax exceed the revenues collected from the tax since 

moving capital to the noncorporate sector reduces tax revenues relative to what would be 

collected if organizational form was not flexible. 

Several papers have examined the extent to which business organizational form responds 

to tax differentials. While evidence is conclusive that business organizational form responds to 

tax incentives, the magnitude of this effect and, ultimately, its impact on who bears the corporate 

income tax is uncertain. Mackie-Mason and Gordon (1997) and Goolsbee (1998) find relatively 

modest-sized effects on incorporation decisions based on time-series analysis; in contrast, relying 

19 While the incidence results based on the Gravelle and Kotlikoff models with endogenous organizational form are 

ambiguous when compared to the traditional formulations of the Harberger model, these models have much stronger 

predictions for the deadweight loss created by the tax. Both models predict that the deadweight loss of the corporate 

income tax could be much larger than predicted by the traditional Harberger model. The larger deadweight loss is 

important since a portion of the incidence of the tax comes from the deadweight loss and not just the tax revenue 

collected. Thus, when the deadweight loss is larger, the burdens of the tax can far outweigh the revenue collected. 

33 
on variation across states, Goolsbee (2003) finds a quite substantial effect of taxes on 

organizational form. Goolsbee (2003) also explores whether the choice of organizational form 

affects capital intensity and finds little evidence that capital intensity or wages are affected by the 

cross-state variation in corporate taxation. Clearly, organizational form choice is a dimension 

that can affect the revenues generated by the corporate tax; furthermore, as suggested by 

theoretical models, this margin may substantially increase the deadweight loss from corporate 

taxation. What remains less clear, especially given the evidence that suggests that labor demand 

may be similar for firms that switch organizational form due to tax incentives, is whether this 

margin has a substantial impact on the ultimate incidence of the corporate income tax? 

V. Conclusion 

The incidence of the corporate income tax is an important issue for designing tax policy. 

Who bears the corporate income tax can affect overall conclusions about the progressivity of the 

tax system. Policy analysts have often made assumptions about how to allocate the corporate 

income tax in measuring the distribution of tax burdens. A common assumption, based on 

theoretical models of tax incidence, is that capital bears the burden of the corporate income tax. 

Recent empirical work using cross-country data on corporate taxes and wages suggests 

reconsidering this assumption; labor may actually bear a substantial burden from the corporate 

income tax. While this avenue for research seems promising, several statistical hurdles remain 

before definitive judgments can be drawn from this new research. 

This empirical evidence is consistent with theoretical models of corporate tax incidence 

that assume that capital is mobile between countries and that foreign countries do not adjust their 

tax rates in response to a tax change by the domestic country. This theory assumes that capital is 

34 
 

mobile between countries and that capital investment varies with tax policy. In the past, many 

economists would have argued against both of these propositions; however, recent empirical 

evidence on both capital mobility (in general and with respect to tax differentials) and the 

elasticity of investment with respect to the user cost of capital (including tax-induced changes in 

the user cost) support these assumptions. Thus, new evidence on capital mobility and investment 

corroborate the view that labor bears a substantial burden from the corporate income tax. 

These arguments about capital mobility and investment focus on the main channel for the 

corporate tax affecting labor income is through changes in the capital stock. As Arulampalam, 

Devereux, and Maffini point out, these general equilibrium effects are not the only mechanism by 

which corporate tax liabilities can affect workers. Moving beyond the traditional models with 

competitive markets, labor can bear part of the corporate tax if wages are determined as a bargain 

over rents. This channel has received much less attention in terms of theoretical models and 

empirical work. Further exploration of this channel could be fruitful for determining the ultimate 

burden of the corporate income tax. 

35 
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