The Incidence of the Corporate Income Tax on Wages: Evidence from Canadian Provinces

Corporate income tax (CIT) incidence is an important and contentious issue in tax policy discussions. Much of the focus in the recent literature and in policy discussions concerns the allocation of the burden of the CIT between owners of capital and labour. Since income from capital tends to be concentrated with wealthier individuals, if the burden of the CIT falls largely on capital it increases the tax system’s progressivity. On the other hand, if the tax is borne mostly by labour through lower wages, the CIT is less progressive. Despite the importance of this issue in policy discussions, empirical evidence is quite limited and the results are mixed; there is a particular dearth of empirical research on the incidence of corporate taxes in a Canadian setting. According to theoretical open economy general equilibrium models, the burden of the CIT may partly, and possibly largely, fall on labour. In these models, an increase in the CIT reduces the return to capital, causing capital to leave the jurisdiction, which lowers the marginal product of labour and ultimately wages. Thus, the CIT can have a negative indirect effect on wages through its impact on labour productivity by way of its impact on capital. However, the magnitude of this effect depends critically on several modelling assumptions and parameter values related to the size of the country, the degree of capital mobility, the nature of competition in the output market, etc. An emerging empirical literature investigates the effects of CIT on wages by way of this indirect transmission mechanism. Empirical studies in this vein include Hassett and Mathur (2006, 2015) for a cross-section of countries; Desai, Foley and Hines (2007) and Felix (2007, 2009) for the U.S. They all find evidence in support of the relevance of the indirect channel using national aggregate data. Other studies, such as Carroll (2009) and Felix (2009) for the U.S., examine corporate tax incidence at the subnational level, and find that a substantial amount of the burden of the CIT falls on workers. However, a recent study by Clausing (2013) using OECD data casts some doubt on the relevance of the indirect channel and the empirical results of some of the above studies. Another strand of research has focused on an alternative channel whereby the CIT affects wages directly. In these models, firms earn economic rents due to imperfect competition and/or other market frictions. Firms and workers bargain over these rents, allowing workers