More John Cochrane on the corporate tax burden

Here is a long and very interesting post with many distinct points.  Here is one of them:

So the entire corporate tax is pre-paid, or borne, by the stockholders who are unfortunate enough to be around when the corporate tax is announced.  Anyone who buys shares after the corporate tax is imposed gets the shares at a lower price, so his or her return is entirely unaffected by the corporate tax.

People who buy shares after the corporate tax is imposed bear no burden of the tax. The corporate tax does not affect the rate of return received by current owners at all, because they got to buy at low prices.

So much for corporate taxes soaking the rich. This is an important fact, missing in all the distributional analysis I have seen.

Here is another:

Pietro Peretto reminds me there is an active literature on optimal taxation in endogenous-growth economies, including his Corporate taxes, growth and welfare in a Schumpeterian economy , Schumpeterian Growth with Productive Public Spending and Distortionary TaxationThe Growth and Welfare Effects of Deficit-Financed Dividend Tax Cuts and Implications of Tax Policy for Innovation and Aggregate Productivity Growth.  Nir Javinovich and Sergio Rebelo have a nice recent “Nonlinear effects of taxation on growth,” in the JPE, Nancy Stokey and Sergio have “Growth effects of flat-rate taxes” also in the JPE, and I have inside information that Chad Jones is working on it too. So, there is no lack of academic literature on the question just which kinds of taxes reduce growth, which of course leads to huge distortions.

Worth a full read.


interesting description which i mostly agree with... whoever holds gets impacted. Future prices are adjusted before future investors buy.

but, um, to say that it doesn't mainly affect the wealthy would be insane, since in reality the wealthy own between 50-90% of stocks (depending if you call the 1% or 10% the wealthy, and depending on pension fund investment allocation in stocks etc). So, if you raise effective corporate tax, 50-90% of the effect will be on the wealthy almost explicitly through his argument. so.... he didn't really think that through.

Theoretically it could hurt anyone... but the current group who would be hurt is the you can argue net negative effects to wealth, but otherwise if its just a penalty on current wealth holders he MAKES THE CASE for why they should be done...

Forgive me for pointing this out, but it’s plain from reading your comment that you didn’t click through to read the post.

Forgive me for pointing this out, but within the narrow context of that part of the tax borne by shareholders Mike is correct. Why are the pre-announcement owners, who bear the burden per Cochrane, not just as wealthy as the post-announcement owners?

Cochrane says,

I think every economist in this debate admits, if some reluctantly, that "corporations" pay no taxes.

(Why the quotes, by the way? Are corporations not real?) Some day I would like conservatives to put forth their entire theory of corporations, what they are and are not, etc. Apparently they are persons or associations of persons when needed for some argument, enjoy all sorts of protections as a result, even are considered to have religious beliefs. Yet they pay no taxes, enjoy limited liability, cannot be imprisoned and, generalizing from Cochrane's view, can't even be fined. They are more fantastical than any creature ever imagined by man.

What does it mean that "corporations pay no taxes?" As far as I can tell it means they take taxes into account in their decision-making, so they pay lower dividends, make fewer investments, hire fewer workers, etc., so that the tax affects a lot of individuals indirectly.

OK. Guess what, I take taxes into account too, when I make my decisions about investment, buying services, giving gifts, and so on. Does that mean I pay no taxes?

It all begs the question. Imagine no federal corporate income taxes in the U.S. permanently. Imagine the boom for the citizens/workers. This would be a good thing. Who cares if a few rich get richer! We could have full employment, end welfare, enjoy all of those things that would come with a sustained booming economy. Then ask why we don't do it?.

There were no federal corporate income taxes before 1909. Why didn't we have full employment and welfare then?

Killjoy. 8(

Very high tariffs.

"So the entire corporate tax is pre-paid, or borne, by the stockholders who are unfortunate enough to be around when the corporate tax is announced."

I believe this claim only holds if the market's expectation is that the announced tax rate is expected to the be the tax rate in perpetuity. If the market's expectation is that the rate will be lowered later, and then it is not lowered, that failure to lower the rate harms the current shareholders. Any time the market changes its expectations about future corporate tax rates, it affects share price. Policy change almost always changes expectations about future policy, but sometimes policy stasis is what is unexpected.

Good points, especially about stasis.

Also, since tax changes are generally discussed and the particulars hashed out for quite some time before they take effect, or don't, it's hardly as simple as an unexpected change out of the blue that goes into effect tomorrow.

Traders will have varying expectations as to the probability of various changes being enacted, and this will affect prices before any decision about taxes is made.

Suppose I think there is more chance of a tax increase than you do. As a consequence, I sell to you, even though our expectations for pre-tax results are the same. If the tax comes you bear the cost only to the extent that the price you paid did not already reflect that difference of opinion.

Simple example: Say the stock is at $60. I think the tax will be enacted and the price will go to $40. You think it won't be, and the price will remain at $60. I sell to you for $50. If the tax comes and the price goes to $40 you have borne not the full decline in value, but only half of it. The other half was on me, the owner before the tax was enacted.

Of course probability assessments and other complications make this a tricky calculation, but it does seem to me that Cochrane is wrong, once we step out of event study world.

"So much for corporate taxes soaking the rich."

I mean, isn't Cochrane being a little hasty here? Sure, shareholders may not be the VERY topmost earners, but they are disproportionately rich and so-called "upper-middle class", aren't they? Doesn't something like 50% of the US have absolutely NO investment in the stockmarket, and a lot more only through 401k pensions?

It feels like this may be more of a mood affiliation thing:

1) *I* as a professor have investments in the stock market, combined with

2) Nobody ever thinks of *themselves* as rich,

Hence if it impacts shareholders then it's not really impacting the rich.

But there are definitely tons of current taxation schemes that are far less progressive than hitting people who invest significant amounts in the stock market.

We have to consider the extent to which professors at top universities like Stanford or Harvard (or GMU) are themselves biased by their relative affluence.

not just relative affluence, also their near 100% job security. short of rape or murder they aren't losing their job, which is extremely rare for people making 100k+ in the "real, non educzation / govt" job market.

To be affluent and have insane job security (once you are inside the pearly gates of the moat protected castle that is education) is certainly distortionary in the extreme

It is important to note that in the course of the original Cochrane post he assumes, for sake of the argument, that corporate shareholders bear the full burden of the corporate tax. I don't think Cochrane himself believes that is true and the limited quotation above is misleading to those who read only that. His is a contra-argument in response to those who make the argument that (presumably current) shareholders bear the full burden of the tax. This is primarily in response to Summers, who has recently argued shareholders bear "most" of the burden. The quoted passage incorporates that assumption. It would be more accurate to quote Cochrane's own summary:

"1) Even if stockholders do bear the burden of the corporate tax, that is entirely the stockholders who are there when the tax is announced. Current stockholders bear little or no burden."

Note to bloggers: I don't think most readers *do* read the full thing, even if it is "worthwhile".

Doesn't his first point also imply that the entire benefit of any reduction in corporate taxes goes to shareholders at the time the reduction is announced ? This is what disturbs those on the left side of the zero sum, distribution-focused debate he refers to.

That's my reaction too. So maybe a reduction in corporation tax should be accompanied by a "one-off, never-to-be-repeated" wealth tax on shareholdings.

Because it will quickly turn into an annual “one-off, never-to-be-repeated” wealth tax on shareholdings

... and Cochrane was pretty clear that he thinks the long-run negative affects of an untrustworthy government are important to avoid.

Yes, exactly this. The relevant distributional question in analysing a proposed reduction in the corporations tax is the wealth distribution of existing, not past shareholders. My suspicion is that they tend to be wealthy (and that the same is true of past shareholder, FWIW) and that this really just serves to muddy the waters.

as shown by the huge return in stocks this year, I don;t think investors have much to fear. the impact of higher or lower taxes is gradually baked into the price

Do y'all remember that chapter of your Econ 101 book that talked about tax incidence? That talked about how the price and quantity of a certain good sold in a Walrasian auction will change based on a tax or subsidy. And that the end result isn't affected by the choice of either taxing the buyer or taxing the seller.

One of these days, I will mathematically generalize this. One of these days, I will show that it doesn't matter if you have a progressive tax, regressive tax, corporate tax, sales tax, income tax, alcohol tax, or whatever. Prices and quantities will adjust to the exact same equilibrium. These debates about corporate taxes will be relegated to the Halls of Stupid Debates, like how many angels can fit on the head of a pin, or whether global warming is a real thing and not a Chinese conspiracy to make U.S. manufacturing noncompetitive.

Until that day comes, and I have that proof on hand, I will simply assume that Krugman is wrong on everything.

It is correct that the tax incidence is often not impacted by whether the buyer or seller is taxed, but different forms of taxes (such as your list above) impact the equilibrium differently and do in fact matter.

"I will simply assume that Krugman is wrong on everything."

True. This is the third (in addition to death and taxes) certainty in the Universe.

I wouldn't know from personal experience. I see Paul Klown's byline and don't waste my eyesight. They couldn't pay me enough for that.

Regarding stockholders. They provide capital. They are the residual owners of net profits (after everybody and the governments are paid). They are the bearers of all (outside bankruptcy and loan restructures, when they lose all and first in the "pecking order") economic/financial losses. They are first charged and last paid. They should command higher returns commensurate with their risks.

Lower corporate tax liabilities increase net returns on capital. So, more capital should flow to the corporations/markets, less to the psychopaths we call politicians.

When that day comes you can claim whatever you like.

But it's not here, and I bet it won't arrive.

In the meantime, if you want to say Krugman is wrong about some things, you would be more credible if you gave actual reasons and analyses and not promises of what you will prove some day.

I'm not sure of what to make of this, but many firms chose to be corporations after the current corporate tax structure was in place.

About five years ago, many FDIC-insured deposit banks converted to (IRC) Subchapter S corporations wherein the taxation is at the shareholder level. I think the numbers of shareholders are limited.

In these elections, the tax liabilities are passed through to the "shareholders" and taxed as if it were their personal income. It seemingly avoids double taxation. There must be other incentives. I wasn't heavily involved in this area. There are concerns for bank supervisors. One is potential for excessive "dividends" to support tax liabilities hampering capital adequacy and maintenance.

Maximum numer of S-Corp shareholders is 100 (some related persons can be counted as one). No non-US resident shareholders permitted.

Let me see if I get this right: a cut in the corporate tax will primarily benefit workers by resulting in an increase in wages, but an increase in the corporate tax will primarily be borne by current shareholders by resulting in a lower stock price. Would this phenomenon apply to Amazon, whose stock price bears little relationship to its earnings? Why would a cut in the corporate tax result in an increase in wages if Amazon pays little in the way of corporate taxes (because Amazon's earnings are small relative to its total revenues)? Similarly, why would an increase in the corporate tax result in a drop in Amazon's stock price? The disconnect between a company's stock price and its earnings isn't limited to Amazon in these high flying times. Cochrane may be right in theory but is he right in practice? Theory holds that the current price for a stock is equal to the discounted present value of the company's future earnings. Does Cochrane believe that's true? Or are there other factors (e.g., psychology) that are more significant?

Of course non-publicly traded corporations also benefit from any potential relevant tax cuts. Very little real estate development and leasing, for example, is via publicly traded companies.

The corporate tax also affects the price of newly-issued stock, and that's where it affects the incentives of the issuing firm, biasing it away from equity financing and towards debt. This makes the whole system more fragile and prone to crises.

Maximum stability is at zero taxes, at which point there will be an absolute minimum of crises.

If the problem is too much debt financing, then stop subsidizing it.

Cochrane doesn't mention the Krugman et al. notes on international shareholders who don't pay US capital gains tax. Makes sense to turn to turn corporate tax into withholding system, where taxes at the corporate level bind only when dividend taxes aren't paid by individuals. Combine withholding with full expensing and Vivian Darkbloom's comments on rates/simplicity from earlier this week, and it looks close to covering all the bases for reform.

Tyler said that it was interesting. He did not say anything about the quality of the paper. Sometimes Tyler should use a word other than "interesting' that suggests a mild endorsement in academia.

The more I think about this, the more I think it is a serious mistake to treat the Trump tax cuts as anything other than an attempt to reduce taxes on the wealthiest people in the country. All the rest of the economic justification is nonsense. To rgue against these proposals on theoretical grounds is to fight on the enemy's terms.

So shareholders who lobby for corporate tax cuts do so with expectation of immediate payoffs in the event of obtaining said tax cut?

This would be a really bad incentive in a system where for practical purposes it is also "legal" to funnel unlimited amounts of money into political campaigns.

Monopolies and stasis are bad for both average wellbeing and national output, thereby contributing to both reduced national might and increased legitimacy of grievances which may contribute to civil strife.

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