One of the least understood concepts in economics concerns the effects of the corporate income tax. Many say the burden of this tax falls totally on the shoulders of the corporations since they actually “pay” the tax. Others see this as a consumer tax since everything the corporation earns comes ultimately from the consumer. While both statements may be partially true, neither gives the complete picture. To gain a better understanding of the effects of such a tax, consider the following example:
The small island country of Koala boasts a relatively free market, private property order. There are five corporations on the island which grow and sell pineapples. Assuming all pineapples to be similar, these businesses, in conjunction with their customers, have settled on a price of $1.00 per pineapple. This price has not been determined by the costs of the pineapple growers, but has been discovered as the market-clearing point satisfactory to both sellers and buyers. It is the price at which supply equals demand.
Now suppose the government of Koala imposes a $.50 per pineapple tax on these corporations. Some claim that since the tax is charged to these businesses, they bear the cost. Others argue that since everything these businesses earn ultimately comes from the consumers, the consumers bear the full burden of this tax. Who is right?
Assume the former are right and the sellers still charge only $1.00 per pineapple. Since the tax has driven up costs, thus reducing and possibly eliminating their profits, some firms must close or move to more profitable areas. This reduction in the number of sellers results in higher prices for buyers since the supply of pineapples has diminished. Thus, consumers bear at least some of the cost of this tax.
Now suppose the latter argument is correct. This means that the businesses would charge $1.50 and remain unaffected by the tax. However, many buyers leave the market at this price, deciding they would rather do without pineapples or grow their own. If this weren’t so, sellers long ago would have raised their prices to $1.50.
As buyers leave, the sellers’ revenues fall. Sellers soon find they are better off bearing part of the tax burden by allowing prices to fall in order to retain more customers. The fact that all sellers have raised prices doesn’t mean they have been protected from the effects of the tax: some buyers still leave the market.
Because of this tax, the resulting price will be somewhere between $1.00 and $1.50. Depending on the nature of the market, the buyer will bear part by paying more than $1.00 and the seller will bear part by receiving less than $1.50. Buyers who can’t afford the higher price and sellers who can’t afford the cut in income will be forced out of the market.
Those who view the corporate tax as either a tax on business or a tax on consumers are right in part, but fail to grasp the entire picture. Because of the high degree of interdependence in the developed marketplace, no governmental act can affect just one group: the well-being of one depends on the continued well-being of all others. Thus, the corporate tax doesn’t fall exclusively on businesses or consumers, but on all those who wish to cooperate peacefully for their mutual benefit. Rather than being a tax on a specific group of people, this disruption of peaceful exchange is a tax on cooperation.