A Macroeconometric Analysis of the Incidence and Economic Effects of the Corporation Income Tax in Canada

Abstract

<p>Even though the short-period shifting of the corporate income tax has been the subject of numerous econometric studies, the issue still remains controversial. The question of whether or not corporate profits taxes are shifted is important because of its implications for the distribution of income, the allocation of resources, and economic growth.</p> <p>A fundamental problem with the existing econometric studies of the short-run shifting of the corporate income tax is the lack of a well defined underlying theory. On one hand, the authors examine the short-run shifting of the corporate income tax while ignoring how the government uses the additional revenues when the tax is raised; that is, they seem to have adopted either a partial-equilibrium or a general-equilibrium full-employment model, when aggregate demand is always fixed at the full-employment level. On the other hand, the inclusion of some Keynesian cyclical variables in their regression equations for the rate of return implies that the authors have implicitly adopted a Keynesian approach. This theoretical inconsistency on the part of empirical investigators of the short-run shifting of the corporate income tax makes their results extremely difficult to interpret.</p> <p>In this thesis we show that in a conventional Keynesian IS-LM model the incidence and other economic effects of the corporate income tax depend on how the government uses the additional tax revenues when the tax is raised. Furthermore, we demonstrate this point empirically by adapting an existing macroeconometric model of the Canadian economy and conducting several experiments involving the corporate income tax. One of the major conclusions of this thesis is that the shifting of the corporate income tax takes place under expansionary conditions in the economy. In other words, the shifting mechanism operates primarily through changes in aggregate demand and real output, not through changes in prices relative to wages, as is assumed in the conventional approach to the corporate income tax.</p>