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Corporate income taxation is very popular among many voters and policy makers because alleged wealthy capital owners are supposed to bear the burden. However, firms may have the possibility to shift the tax burden through different channels. They may pass the burden to consumers through higher prices, to capital by lowering dividends, or to workers in form of lower wages or indirectly via lay-offs.

International competition and mobile capital cast a pass-through to owners or consumers via reduced dividends or increased prices into some doubt, so that shifting a larger part of the burden to employees is likely (see, for instance, Harberger 2008; Arulampalam et al. 2012; Liu and Altshuler 2013). So far, however, empirical evidence on the degree of pass-through of business taxation to employees is rare. To shed some light on the degree of tax shifting, we use an extensive administrative individual panel-data set of employees in Germany to estimate the wage effects of corporate income taxes, putting a focus on differences between socio-economic groups and industries.

For this purpose, we extend the theory on the link of wage negotiations and corporate taxation to heterogeneous labour. We estimate the elasticity of wages with respect to effective local corporate tax rates for different employee groups and industries. We further consider the effects of local corporate tax rates on the regional income distribution measured by the Gini Index and three different entropy measures. Finally, we analyse whether there are differences in tax shifting between tax reliefs and increases of the tax burden.

Corporate Income Taxation and Wage Determination in Germany

The analysis of the degree to which firms are able to shift their tax burden towards their workers through wage adjustments requires a thorough understanding of the corporate taxation and the wage determination process in the country considered. Corporate taxation in Germany is determined at two levels, the federal and the regional level. In general, the federal institutions determine the tax regulation, which is strongly centralized. The tax rate and the tax base of the federal business tax as well as the tax base regulations for the regional business taxation are identical across regions. Regional governments, however, determine the tax rate of the regional business tax. This generates a significant regional variation of the effective tax rate that we exploit in our empirical analysis. For a detailed description of the German Tax System confer Bauer et al. 2017.

In the period of our analysis (1995 to 2004), the wages of about 84% of the employees in West Germany and 76% in former East Germany were determined – directly or indirectly – by wage negotiations, predominantly by negotiations at a regional industry level. Therefore, we use the variation of the average regional effective tax rate at the county level, which ought to be close to the relevant tax indicator used in wage negotiations, which is then merged to individual wages in our employees’ data. The advantage of this procedure vis-à-vis studies using cross-country or firm-level data is that we can estimate the effect with data from a unique economy and that we can observe individual wages instead of average wage levels at the country or firm level.

Distributional and Asymmetric Effects of Business Taxation

In general, the higher mobility of the production factor “capital” vis-à-vis “labour” suggests that labour may bear a substantial part of the tax burden. We argue that the share of the burden borne by a particular group of workers is, however, likely to be disproportional – and that tax policies will result in unintended effects on the income distribution.

We discuss several reasons why the burden of corporate income taxes borne by labour may vary across different groups of employees. Following the basic idea that the tax burden is shifted to the least mobile factors, the highest burden within the group of employees ought to be faced by those workers with the lowest flexibility to avoid it.

Moreover, the degree of tax incidence may rise with the weight entitled to the group by the union’s negotiation leaders. The reelection incentive of union leaders may shift the focus in negotiations toward those groups with the highest degree of membership.

As the total rent in an industry is allocated to capital and labour (as well as further production factors), the group-specific capital intensity is decisive, too. In a capital-intensive industry, the share of capital cost in total cost is higher. Therefore, if the cost of capital rise due to an increase of the tax rate, each employee will face a higher burden. In a labour-intensive industry, more workers pool the risen burden, so that, per employee, the burden is lower.

Given a lack of financing neutrality in the German tax system – that is, that the tax system treats different ways of financing different – an increase of the effective tax rate will increase the user cost of capital differently for different financing structures of the firms. Employees in different industries thus again face different burdens, because the different sectors differ in their financing structure.

Finally, employees with long job tenure accumulated a larger stock of firm-specific human capital, which is less productive in other firms. Additionally, older workers typically have children in school and own an apartment or house. Consequently, they face higher mobility costs to avoid the burden of tax shifting vis-à-vis employees with lower job tenure who are more flexible, on average.

Overall, our theory predicts that the burden of corporate taxation should be predominantly borne by young, unskilled employees, and workers with high job tenure, as well as employees in capital-intensive sectors.

Another interesting issue is whether the profit tax incidence is symmetric, that is, whether tax increases have the same effect in absolute terms as tax reliefs. We argue that the analysis must take the role of wage rigidities into account.

There is ample evidence that downward nominal and real wage rigidities characterize the labour market (e.g., Altonji and Devereux 2000; Bauer et al. 2007; Behr and Pötter 2010; Dickens et al. 2007; Fehr and Goette 2005; Goette et al. 2007; Knoppik and Beissinger 2003). For firms covered by wage bargaining, the negotiated wage acts as a minimum wage. Wage reductions, thus, are only possible in a typically small bracket of voluntarily paid higher wage levels; stronger reductions have to be adjourned until the next bargaining. Unions, in turn, try to prevent wage cuts (Holden 1994), while supporting wage rises. Then, significant real wage cuts are only possible by inflation or productivity growth. In low-inflation economies such as Germany, however, the inflation effect on real wages is of limited power.

Firms may also hesitate to cut wages, as wage cuts may increase the probability of losing productive workers. Moreover, workers may react to wage cuts by reducing their effort, since they consider nominal wage cuts as unfair (reciprocity; see, e.g., Elsby 2009, Fehr and Gächtner 2000, or Kahneman et al. 1986), and increase effort when wages rise (efficiency-wage theory; see, e.g. Akerlof and Yellen 1990 or Stiglitz 1976). These considerations suggest that tax policies that induce an incentive to cut wages (tax increases) ought to have smaller wage effects than policies that induce wage increases (tax reliefs).

Key Findings

Our empirical results suggest that labour bears a significant burden of corporate income taxes: companies shift 65% to 93% of the business taxation to labour through real wage adjustments. We show that a significant part of the deviating estimates on this incidence effect may root in different numbers on the ratio of wage sum and tax bill used. The estimates of the elasticity of wages with respect to the tax rate are similar among many studies, but the interpolated translation into “how much of an additional unit of tax burden is shifted in percent” differs and causes dispute. Applying to our point estimators for the tax elasticity of wages alternatively the ratio documented in Arulampalam et al. (2012), or the ratio seemingly used in Fuest et al. (2015), the incidence effect ranges from 29% to 41%, respectively from 32% to 46%.

As expected, tax rate increases involve significantly lower incidence effects than tax rate decreases. The effective regional corporate tax rate indeed has a significant effect on the wage distribution: corporate taxation rises inequality. Following our evidence, firms pass through corporate taxation especially to workers who work in unskilled jobs, or who have accumulated already ten or more years of tenure. Job mobility enables workers to elude tax shifting, so that especially employees who stay on their jobs are affected. Unemployment experience also increases the risk of suffering from corporate tax shifting. Additionally, we find significant differences between industries, as expected.

Therefore, business taxation has unintended distributional effects on wages. Tax reductions for businesses, or the abolition of corporate taxation, may, ceteris paribus, increase wages and reduce wage inequality, which produces purchasing power, and, surprisingly, might improve social cohesion. These consequences ought to become part of corporate tax policy discussions.


Our paper:

Bauer. Th., T. Kasten, and L.-H. Siemers, Business Taxation and Wages: Redistribution and Asymmetric Effects, MAGKS Papers on Economics 2017-32. Link:

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