Distribution of Burden of the Corporate Tax

Introduction

Tax is an obligatory commitment imposed by a government authority, regardless of the specific nature of administration delivered to the citizen consequently and not forced as punishment for any offense[1]. The growth of an economy broadly depends upon various factors such as per capita income, ease of doing business, infrastructural developments etc. But beyond all this there a significant amount of contribution in the upliftment of the economy depends upon the efficient taxing structure in a country. There is distribution of burden of tax in corporate.

In fact, the efficient taxing structure can stand as a major source of revenue for the government. As much as people think that their money is directly going into the treasury of the government, there also exist a lot of corruptions, evasions to escape the payment of tax. The efficient taxing policy should “allocate, distribute and stabilize” the funds in the economy[2].  The taxing framework in India is a three-level set up i.e. the taxes are collected by the central government, state government and the local municipal corporations of the respective states.

A significant question that remains a conundrum in the taxation system is the incidence of the corporate tax. Along standing process in tax incidence analysis is that real burden based on real allocations and not on price level or choice of consumers[3]. The corporate tax goes about as a component for collecting income taxes and diversifies the framework and it serves as a screen against evasion of tax by high income citizens. Though in the short run there is an understanding that the corporate tax shall be borne by the capital owners there is a grey area in understanding as to who bears this final burden and the impact on the investment policies.

This paper shall discuss the concept of Incidence of Tax and in more particular the shifting and the distribution of burden of the corporate tax in India. Tax incidence is not an accounting exercise but a scientific portrayal of changes in economic equilibria when taxes are changed[4]. The response of the tax system to increase in income can be the elasticity of the tax system, i.e. the extent to which the tax system given an increased return with every increase in income[5]. In many cases the incidence is on the person who ultimately bears the money burden of tax this is not necessarily have to be a consumer.

In a corporate firm or an organization, the burden is also shifted on the employers, in the profit of the company and to the consumers. The research the paper will focus on how the burden is shifted and on what basis such burden is distributed among the consumers, employees and impact of it in the companies’ investment choices. In the line of understanding this distribution, the research attempt to focus on various factors that determine the shift of the tax and what is the behavioral impact of this shift on the consumers.

Since the core concept of incidence of tax depends upon understanding of few concepts of economics the research will be an interdisciplinary study between economics, law and consumer behavior. Adam’s Smiths concept of cannons of taxation elaborates that the tax payer should have the ability to pay the tax. The tax should be distributed in such a way the ability of the tax payer is not compromised. In the case of Corporate tax, it is the wealthier individual or the capital owner of the firm who bears the tax. So, one of the objects of the research is to understand the progressivity of the corporate tax.

But the problem arises when the distribution of tax is considered. There is no hard and fast rule as to how this distribution happens. Though there is a lot of literature on the development of concepts like incidence of tax, the shift of burden in terms of corporate tax is still a controversial and debatable subject. The theoretical complexity is that there is not standard position in this subject matter, different thesis debate different issues and shortcomings.

Hence, the paper tried to address this research problem by analyzing the different existing research works and will also try to bring about a collective understanding. The final object of this research is to understand as a whole how the incidence of tax takes place in the corporate tax and to understand the impact of it on consumers. This research shall help the students trying to understand the incidence of corporate tax to an extent.

Theories of Incidence of Tax

Raising corporate income taxes has often been a viable route for governments to shift the tax burden onto the people who can actually afford it. So, if taxes were initially borne by the capital owners then who bears it finally and how does this distribution happens. Considering the fact that the payment of tax also forms a significant part of the investment and capital decisions there is a need for research to under the distribution of burden.

This chapter shall dwell into the different theories in the Incidence of tax in general which shall in turn help us in understanding the concept of incidence of corporate tax in particular. The Doctrine of Incidence of Tax[6] dates back to centuries ago. In fact, there are around ten theories that propound the concepts of Incidence of tax. Nevertheless, this research shall only include major theories related to incidence of tax.

The Earliest Theory:

In the earlier time before Adam smith’s era, the theory of incidence of tax found its base in the works of Sir William Petty.  Mr. Petty believed that the revenue of revenue from land can be done in two ways: either by setting apart a proportion of the whole Territory for Public Uses”, or by taxing a part of land owned by the landlord by land tax. Such a land tax, the certain portion of tax will be borne partly by the landlord and partly by the consumers.

As reasoned by Petty “For it is not only the Landlord pays but every man who eats but an Egg, or an Onion of the growth of his Lands”. In the further developments of this theory it came to be believed that the all the taxes therefore in last resort fall upon the rich and idle consumers of the distributors, retailers who are not being refund by anybody i.e. the wage earners[7] should pay the price for what they consume.

The Physiocratic Theory:

This theory was propounded by the founder of the sect, Quesnay and finally completed by various works of Turgot, a French economist & Statesmen. In the times when the Industrial and commercial growth did not produce much wealth to the countries and agriculture was the sole income generator in the countries, the physiocrats believed that the taxes should be collected from the agricultural land owners and the burden of incidence should always be on the land[8]. This was the cardinal belief of the physiocratic theorists.

The Diffusion or Optimistic Theory:

This theory mentions that taxes “equates and diffuses” itself. This theory proposes that government may force such taxes which are most easily assessed and collected and will have the least impact to national wealth. It favours indirect tax assessment, trusting the trading laws to distribute the burden of taxation over the wide population of the country. The diffu­sion theory of taxation is based on the assumption of impeccable competi­tion and complete mobility of all economic operators in the country.

Factors that Influence Incidence of Tax

The factors that influence incidence of tax are:

Elasticity of Demand & Supply

The traditional taxation principle is that the incidence of a tax is based upon the elasticates of the “supply and demand” for the taxed good[9]. The elasticity of demand is nothing but the change in the demand for the product. Elasticity of supply is measure of change in the quantity supplied due to the change in the price.

As the price increased or decreases it in turns causes the shift in the burden of paying the tax. In the cases where there is an inelastic demand/supply for the product the burden also doesn’t shift much. But when the demand or the supply is elastic (more than 1) the burden also shifts on the end-consumer.

Price

The shifting of the tax primarily takes places through the changes in the price for the good and services. In the cases where the taxing on the product doesn’t impact the price of the product, the shift of burden also doesn’t take place.

Availability of substitutes

Tax levied on a commodity having no nearby substitutes, can be effectively moved to the end-consumer. Here the end-consumer can’t locate an elective item as substitute to fulfil his interest. Therefore, the consumer will purchase the product paying higher prices and takes the burden of tax on himself. On the other side when the product as a substitute with a less price and no tax, the consumer will choose that product and the burden on the high-priced product is borne by the seller itself.

Distribution of Burden of Incidence of Corporate Tax

The question of who bears the final tax burden has always been in the grey of debates and research. In the previous chapter the paper elucidated on the concepts of factors determine the incidence of tax in general. In this chapter the paper will try to compare the factors of those corporate tax in particular. The corporate tax generally is a progressive tax. Like the other taxes on the commodities shift on the consumers, the burden in the corporate tax is also shifted and burden is distributed among the capital and the labor.

The corporate taxation framework can influence the business decisions such as investments, capital allocation. The changes in these decisions can affect the wage earners, output prices. The way the corporate t ax affects or creates an impact on the way earners are said to be indirect as they don’t have any direct bearing of those corporate taxes paid by the companies. In India since the tax is paid by the tax payers on the basis of their income level, the higher the income level, the higher the tax rate.

Even the corporate tax the same process follows i.e. when the corporate tax is distributed among the labor and capital, the high wage earner(labour) shall bear the higher burden of distribution. If the corporate tax burden is divided evenly between capital and labor, the tax remains progressive but more progressive compared to the cases where the corporates bear the entire tax burden. The factors mentioned in the incidence of tax like price, elasticity off demand and supply can also influence the corporate tax.

For Instance, its assumed that the production(q) of business is conducted with the labour(L) and capital(K) then it is [Q (K, L)]. Further the company is sourced by the combination of debt(D) and equity(E). The wage paid for the labour can be represented by w and the r is the return for the creditors who funded the business. P shall denote the post corporate tax rate of return to decide the capital and investment decisions which in turn might affect the price of the product, production or distribution decisions. C is determined by the corporate tax. It is reduced to the following equation so as ti determine the effect of taxation on the after-tax profits.

Formula: P = [ Q (K, L) – W – R] (1-C)

Impact on the Consumers due to the shift in the burden

A rational consumers’ buying preferences would depend on a various factor such as price, substitutes, brand loyalty, level of tax aggressiveness and other demographic factors like income, gender etc. The most significant part of deciding the price of the product can have a strong impact on the consumers buying preferences which might in turn affect the turnover of the company.

The consumer spending is based the theory that the consumers spending on a product will not increase or decrease over a period of time if the income of the consumer keeps fluctuating. In the place of income if the tax is substituted, the consumers spending over a product tends to change only when the tax on the particular product is consistent. Therefore, a permanent change in the tax rate for the particular product will have the effect on the consumer spending on a larger scale than when the tax rate is fluctuating.

The consumer preferences on buying product with a higher tax rate might also depend on the significance of the product to the consumer i.e. unavailability of the substitute products. Therefore, it can be said that the incidence of the tax definitely has a impact on the consumers buying preference and to what extent the impact is taking place can only be identified based on a in-dept experiment studying the consumer behavior in relation to the particular product or services with that of its substitutes.

Conclusion

The last decade has seen a number of changes in the tax framework which has impacted in changed in the Indian economy. In my opinion the imposition of heavy corporate tax discourages the use of capital, also reducing the return on capital for the entire economy even though it meant to be a progressive tax form. Further, in my understating it is found that the incidence is inevitable but the distribution of incidence is what makes the big impact whether it is consumers or at the corporate level.

Nevertheless, I feel the companies try to compensate the incidence of this tax burden by the way perquisites to the labor, discounts & offers to the consumers etc. What needs to be given consideration is the fact that this shift in the burden shouldn’t be entirely taken upon by the consumers which is again bad the economy and to the company in terms of the turnover.  There is a further scope of research in the areas of consumer behavior with reference to shifting in the burden of corporate tax. Therefore, the research paper has tried to answer the research question in a simple manner without dwelling into the complex economical calculations. And it is understood that the Consumer spending and preferences will react more strongly to a permanent than to a temporary tax change. And the incidence of corporate tax is shifted upon the labor and consumers in different propositions. But there are not concrete distribution criteria or hard and brick rule for this distribution which again gives a scope for future research.

References:

[1] Gaurav Akrani, What is Tax? Definition – Adam Smith& 39; Canons of Taxation, https://kalyan- city.blogspot.com/2010/12/what-is-tax-definition-adam-smith.html (last visited Jul 29, 2020).

[2] Musgrave, R., A., (1973), “Public Finance in Theory and Practice”, McGraw Kogakusha Ltd., P.,778.

[3] Fullerton, Don, “Tax Incidence – Working paper”, National Bureau of Economic Research, (8) 2002

[4] Incidence of Taxation – MA Economics Karachi University.

[5] Sandip Sarkar, Corporate Income and Incidence of Corporate Taxation, 32 Economic or Political Weekly, 413– 416 (1997).

[6] Edwin R. A. Seligman, On the Shifting and Incidence of Taxation, 7 Publications of the American Economic Association 7–191 (1892), https://www.jstor.org/stable/2485667 (last visited Oct 3, 2020).

[7] Steuart, “An Inquiry into the Principles of Political Economy,” 1767, Book V., Chap. iii. In Collected, Ed. of 180a, I N, 185

[8] Edward Alsworth Ross, Seligman’s “Shifting and Incidence of Taxation”, 3 The Annals of the American Academy of Political and Social Science 52–71 (1893), https://www.jstor.org/stable/1008912 (last visited Oct 3, 2020).

[9] H. Dalton, Principles of Public Finance, 14th ed. (London: Routledge and Kegan Paul, 1954), Chs. 7 and 8.