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When Labor Shows Capital Who’s the Boss

Write-Off: The Tax Blog

I teach a class here at the Kenan-Flagler Business School at UNC where we discuss an employee negotiating how much they will get paid by their employer. My students invariably think the corporation will prevail and get the long end of the stick—these students come conditioned by society to believe that when the giant corporation and the puny employee face off in a compensation clash, a salary show-down, or a bonus brouhaha, the corporation has all the bargaining power, and, will be able to run roughshod over the powerless employee.

That kind of thinking largely dictates how we regulate compensation. For example, we set a minimum wage, presumably because absent some government protection, giant firms would take advantage of their helpless employees. We have a whole host of regulations and laws that protect employees from employers because deep down, we seem to fundamentally believe that corporations will abuse their employees absent these laws. This thinking is especially prominent on the left side of the political aisle—protect weak and powerless employees from powerful employers.

With one exception: Democrats are currently seeking to undo much of the Tax Cuts and Jobs Act, including increasing the corporate tax rate. One question in this debate is who would be worse off as a result such a tax hike. This question, the “incidence of corporate taxation” question, is an age-old economics question that gets at who is actually made worse off because of a tax increase. Is it shareholders, who will suffer smaller dividends and diminished share prices if taxes increase? Is it employees, who might have their wages cut if taxes increase? Or, maybe it is someone else (customers, etc.).

As with much of tax policy, there is a big political divide on the question. The answer endorsed by the left is that shareholders, as the owners of capital, bear most of the burden of the corporate tax. Why? If the democrats in Congress pass a corporate tax increase, as they are currently proposing, they do not like to think that employees may actually end up paying some of that tax increase and being made worse off. This belief is especially important this time around because President Biden has promised not to pass taxes that will make households lower than the 98th percentile of income ($400,000) worse off (always looking out for the 97 percenters!). Rather, it would be politically convenient if wealthy shareholders, as the owners of capital, are the ones that are made worse off. Even better if they are wealthy foreign shareholders. As a result, democrats campaign for corporate tax increases that they claim will be borne by the well-heeled capitalists. So, what does it really mean that capital bears the burden of the corporate tax, and employees do not? It means that when the corporate tax rate goes up, corporations are powerless to decrease the wages of employees, even over the long term.

So, on one hand, one justification for the minimum wage is that employees are so powerless and employment markets so one-sided that the federal government must place its thumb on the scale on the side of the employee so they can get paid enough. Absent that, the corporation would be able to abuse the employee. But, when a tax increase comes, the corporation has little power to pass those extra tax costs on to employees. In the tax increase case, the story goes, the powerless and weak corporation, instead, just has to face the tax increase head on, placing the burden of the tax on shareholders, as the impotent corporation is unable to pass part of the pain on to employees.

In the minimum wage context, employees are assumed to be powerless and rely on the mercy of the state to be justly compensated. But, when thinking about who will be hurt by a corporate tax increase, labor shows capital whose boss—employees have the power, dictate the terms, and, firms are powerless to pass their increased taxes on to their employees (even in times of relatively high unemployment). Such disparate and contradictory stories, while politically expedient, are logically irreconcilable.

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