Who Really Pays Taxes?

By :: June 26th, 2008

Less than an hour after Howard Gleckman posted a blog entry on the presidential candidates’ tax plans, a question came in about TPC’s finding that Senator Obama’s plan would increase taxes of a low-income elderly couple by $150. How, the commenter asked, could that happen if Obama said he’d eliminate taxes for elderly households with income under $50,000?

The answer has two parts, one easy and one more complicated.

First, Obama wants to eliminate individual income taxes for most elderly families. (Two-thirds of the elderly have income below $50,000 and less than a quarter of those pay any income tax now.) But he increases corporate income taxes, which indirectly affects the elderly (and others who own assets).

And that gets to part two of the answer, what economists call “tax incidence”—who actually pays a tax. We assume that the incidence of the corporate tax falls on people who own assets by lowering their pre-tax rates of return. This assumption is controversial.

Clearly, somebody must pay the tax. It could fall on shareholders, employees, customers, or a combination of the three. It could even affect asset income or wages more broadly, cutting returns for investors who own non-stock assets or reducing compensation for workers at firms outside the corporate sector.

Economists agree on the incidence of some taxes—the individual income tax falls fully on people who earn the taxed income, for example—but reach different conclusions on others, including the corporate income tax. For a long time, the conventional wisdom held that the corporate tax burden landed on all owners of capital, not just corporate stockholders. Some—but not all—models show that, under certain circumstances, much of the tax can fall on workers. TPC follows the Congressional Budget Office’s practice of assigning corporate tax incidence to all owners of capital in proportion to their income from capital.

So that’s how a poor elderly couple gets a tax hike from Obama. On average, low-income older people own some capital—stock in their retirement funds, homes, or maybe mutual funds—and that capital bears some of the corporate tax. Obama’s plan would increase corporate taxes and poor older couples would bear some of the cost—not all of them and not much of the cost but enough to make their average federal tax bill rise.

This story has two related lessons. First, you can’t assess the impact of candidates’ proposals without poking around in the fine print. Second, seemingly odd outcomes generally spring from less than obvious details and interactions.