Taxation of Business Income
Taxation of Business Income
An NBER conference on Taxation of Business Income took place October 12 in Cambridge. Research Associates Joshua Rauh of Stanford University and Owen M. Zidar of Princeton University organized the meeting, sponsored by the Smith Richardson Foundation and the National Science Foundation. These researchers' papers were presented and discussed:
James R. Hines, University of Michigan and NBER
Corporate Taxation and the Distribution of Income
Corporate income taxation affects income distribution both by changing relative returns to capital and labor and by reducing corporate activity. A smaller corporate sector entails a larger non-corporate sector. Due to the riskiness and relatively undiversified ownership of non-corporate business, expansion of this sector of the economy contributes to income dispersion and thereby increases ex post income inequality. This effect can be so large that higher corporate taxes are associated with greater income inequality even when the corporate tax burden falls entirely on capital that is owned disproportionately by the rich.
Eric C. Ohrn, Grinnell College
Corporate Tax Breaks and Executive Compensation
Ohrn studies the effects of corporate tax changes on income inequality. Using state corporate tax rate changes as a setting, they show that cutting state corporate tax rates leads to increases in income inequality. This result is robust to using regression and matching approaches, and to controlling for a host of potential confounding variables. Contrary to the effects of tax cuts, Ohrn finds no effects of tax increases on income inequality at the state level. They then use data from the IRS Statistics of Income to explore the mechanism behind the rise in income inequality. They find tax cuts lead to higher reported capital income and a decrease in wage and salary income. These effects are concentrated among top earners, and they finds no effects for those reporting less than $200,000 in income. This result provides evidence that one mechanism for the relation between tax cuts and inequality is that wealthy individuals shift their income to reduce taxes while others do not. Finally, Ohrn explores the effects of corporate tax cuts on capital investment using data from the Annual Survey of Manufactures. They find that tax cuts lead to an increase in real investment, suggesting a trade-off between investment and inequality at the state level.
Ufuk Akcigit, University of Chicago and NBER; John Grigsby, University of Chicago; Tom Nicholas, Harvard University; and Stefanie Stantcheva, Harvard University and NBER
Taxation and Innovation in the 20th Century (NBER Working Paper No. 24982)
This paper studies the effect of corporate and personal taxes on innovation in the United States over the twentieth century. Akcigit, Grigsby, Nicholas, and Stantcheva use three new datasets: a panel of the universe of inventors who patent since 1920; a dataset of the employment, location and patents of firms active in R&D since 1921; and a historical state-level corporate tax database since 1900, which the researchers link to an existing database on state-level personal income taxes. Their analysis focuses on the impact of taxes on individual inventors and firms (the micro level) and on states over time (the macro level). Akcigit, Grigsby, Nicholas, and Stantcheva propose several identification strategies, all of which yield consistent results: i) OLS with fixed effects, including inventor and state-times-year fixed effects, which make use of differences between tax brackets within a state-year cell and which absorb heterogeneity and contemporaneous changes in economic conditions; ii) an instrumental variable approach, which predicts changes in an individual or firm's total tax rate with changes in the federal tax rate only; iii) a border county strategy, which exploits tax variation across neighboring counties in different states. Researchers find that taxes matter for innovation: higher personal and corporate income taxes negatively affect the quantity, quality, and location of inventive activity at the macro and micro levels. At the macro level, cross-state spillovers or business-stealing from one state to another are important, but do not account for all of the effect. Agglomeration effects from local innovation clusters tend to weaken responsiveness to taxation. Corporate inventors respond more strongly to taxes than their non-corporate counterparts.
Juan Carlos Suárez Serrato, Duke University and NBER
Unintended Consequences of Eliminating Tax Havens (NBER Working Paper No. 24850)
Suárez Serrato shows that eliminating firms' access to tax havens has unintended consequences for economic growth. They analyze a policy change that limited profit shifting for U.S. multinationals, and show that the reform raised the effective cost of investing in the US. Exposed firms respond by reducing global investment and shifting investment abroad -- which lowered their domestic investment by 38% -- and by reducing domestic employment by 1.0 million jobs. Suárez Serrato then shows that the costs of eliminating tax havens are persistent and geographically concentrated, as more exposed local labor markets experience declines in employment and income growth for over 15 years. Suárez Serrato discusses implications of these results for other efforts to limit profit shifting, including new taxes on intangible income in the Tax Cuts and Jobs Act of 2017.
Suresh Nallareddy, Duke University; Ethan Rouen, Harvard Business School; and Juan Carlos Suárez Serrato, Duke University and NBER
Corporate Tax Cuts Increase Income Inequality (NBER Working Paper No. 24598)
Nallareddy, Rouen, and Suárez Serrato study the effects of corporate tax changes on income inequality. Using state corporate tax rate changes as a setting, they show that cutting state corporate tax rates leads to increases in income inequality. This result is robust to using regression and matching approaches, and to controlling for a host of potential confounders. Contrary to the effects of tax cuts, the researchers find no effects of tax increases on income inequality at the state level. They then use data from the IRS Statistics of Income to explore the mechanism behind the rise in income inequality. The researchers find tax cuts lead to higher reported capital income and a decrease in wage and salary income. These effects are concentrated among top earners, and the researchers find no effects for those reporting less than $200,000 in income. This result provides evidence that one mechanism for the relation between tax cuts and inequality is that wealthy individuals shift their income to reduce taxes while others do not. Finally, Nallareddy, Rouen, and Suárez Serrato explore the effects of corporate tax cuts on capital investment using data from the Annual Survey of Manufactures. They find that tax cuts lead to an increase in real investment, suggesting a trade-off between investment and inequality at the state level.
Thomas R. Tørsløv and Ludvig S. Wier, University of Copenhagen; and Gabriel Zucman, University of California, Berkeley and NBER
The Missing Profits of Nations (NBER Working Paper No. 24701)
By combining new macroeconomic statistics on the activities of multinational companies with the national accounts of tax havens and the world's other countries, Tørsløv, Wier, and Zucman estimate that close to 40% of multinational profits are shifted to low-tax countries each year. Profit shifting is highest among U.S. multinationals -- the tax revenue losses are largest for the European Union and developing countries. The researchers show theoretically and empirically that in the current international tax system, tax authorities of high-tax countries do not have incentives to combat profit shifting to tax havens. The authorities instead focus their enforcement effort on relocating profits booked in other high-tax places -- in effect stealing revenue from each other. This policy failure can explain the persistence of profit shifting to low-tax countries despite the sizable costs involved for high-tax countries. The researchers provide a new cross-country database of GDP, corporate profits, trade balances, and factor shares corrected for profit shifting, showing that the global rise of the corporate capital share is significantly under-estimated.
James F. Albertus, Carnegie Mellon University
Does Foreign Tax Arbitrage Promote Innovation?
Albertus identifies a new category of fiscal policy instruments -- those regulating profit shifting activity -- as an important determinant of corporate innovation. Using confidential microdata on the foreign and domestic operations of U.S. multinational firms, they document that after an unexpected policy shock that facilitated foreign tax arbitrage, U.S. multinationals shifted more of their taxable income and intellectual property to low tax countries. This increased the after-tax return to innovative activity. In response, U.S. multinationals increased their innovation in the U.S., whether measured using R&D expenditures, patent applications, or patent citations.
Alisa Tazhitdinova, University of California, Santa Barbara
Entrepreneurial Entry vs Income Shifting, and the High Cost of Incorporation
Drawing on administrative panel data covering the full population of entrepreneurs in the U.K., Tazhitdinova studies the effects of lower tax liability on entrepreneurial entry and income shifting. They find that a 10% increase in savings from incorporation leads to a 2.64% increase in the number of new entrepreneurs, and a 2.25% increase in income shifting. Nonetheless, despite large tax savings to incorporation (exceeding 10 pp in some years), a substantial proportion of business owners fails to incorporate. Using a revealed-preference approach, Tazhitdinova estimates an average yearly cost of incorporation of more than £3,750 per entrepreneur. These findings imply that income shifting through incorporation is not the primary avoidance channel for the self-employed and that distortions to the choice of organizational form are moderate. At the same time, the large perceived cost of incorporation indicates that barriers to entrepreneurship remain large.