Corporate Earnings and Tax Shifting in U.S. Manufacturing, 1930-1968

Abstract

FEW economic magnitudes have commanded as much attention from economists as the earnings of capital. Despite this emphasis, it is interesting that there exists scant empirical evidence concerning the determinants of capital income over the relatively long run. This is rather surprising since the short-term behavior of profits has come under considerable scrutiny by econometric model builders. Existing evidence concerning long-run behavior stems primarily from recent studies of the incidence of the corporation income tax.' In order to isolate the effects of the tax, investigators have had to identify and eliminate the effects of the nontax determinants of profit. As would be expected, conclusions regarding tax incidence have turned out to be extremely sensitive to the underlying model of profit. It is the purpose of this paper to ascertain the extent to which a model based upon standard competitive behavior is capable of explaining the time path of corporation earnings over a period of almost forty years. Since most incidence studies have been based upon models which explicitly or implicitly assume nonprofit maximizing behavior, such a study will provide a useful extension of the empirical evidence concerning the behavior of profit as well as a test of the relative efficacy of standard economic theory. Furthermore, unlike existing studies, the model will be tested in such a way that the contribution of such determinants of profit as technological change, capital intensity and aggregate demand can be isolated. Since indirect evidence on such factors exists from studies of aggregate production functions and business cycle behavior, the plausibility of the estimates can be determined. Finally, the model can be used to provide additional evidence concerning the shifting of the corporation income tax. If the model is specified correctly, the introduction of a corporation income tax variable into the estimating equation should have little effect. In what follows, a model of corporation earnings is developed and tested for the manufacturing sector of the United States economy for the period 1930-1968. The model is based upon the hypothesis that the return to capital depends upon its marginal productivity and short-run fluctuations in output. It is found that the model does quite well in explaining the time path of manufacturing earnings over the sample period; all coefficients are statistically significant, have the right sign, and are of reasonable magnitude. These estimates also provide evidence concerning the underlying aggregate production function. Specifically, the estimates imply an elasticity of factor substitution of less than one, and technical progress which is not solely of the Harrod-neutral variety. At this point the question of short-run corporation tax shifting is taken up. A suitably defined tax variable is introduced into the statistical model. It is found that the tax variable does not significantly add to the explanatory power of the model; its coefficient is small in absolute value and is statistically insignificant. It is concluded, therefore, that corporations bear the full burden of the corporation income tax in the short run.