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For the most part, I’m fairly liberal in my beliefs. There are a couple of places where I diverge from the liberal dogma and one of those is the taxation of corporations. Every once in a while, you will hear a howl of protests from the left about how {insert evil corporation here} is not paying their fair share in taxes or that businesses as a whole are not paying enough taxes. On a state level, the latest protest comes from Rod Blagojevich, the Governor of Illinois, who is using the “big business as tax bogeyman” argument to push through his plan to quadruple taxation of businesses by instituting a gross receipts tax to replace the current net income tax.

Now, I’m not here to defend the use of tax strategies that shift income from state to state to avoid income taxes. I think they are shady and they’ve caused problems for every company that is not doing it (and it’s far from a majority that are using these strategies). I’m also not here to say that businesses shouldn’t pay taxes. I’m here to discuss the economic incidence of taxation and who really pays when business taxes are raised.

It was brought on by a discussion in a forum of people that I often disagree with, but respect (for the most part). They raised the idea that if corporations paid their fare share in taxes, we could have universal health care. That’s the basic idea of Governor Blagojevich’s plan, though he’s raising money for other pet projects along with health care. Again, I’m not arguing what we should do with health care (though it is a broken system).

Business entities don’t really exist. They’re a legal fiction created by governments so that individuals can raise money to expand their businesses easily and will take chances without putting all of their own assets on the line. In the end, businesses are really an extension of the owners and nothing more. For instance, if a business goes under what does the corporation itself lose? Nothing, because it had nothing to begin with. Who loses? The owners that put their money into the corporation and the employees that were employed. The economic loss of a business going under is borne by individuals, the owners and employees that will no longer generate income from that business. You can extend this to creditor in the above example. It’s the owners of the corporation that ultimately bear the loss through smaller returns on the money that they invested.

A similar situation happens with taxes. Let’s say that business taxes are immediately raised by 20%. Businesses have three choices: they can eat the tax, they can raise revenues to cover the increased tax, or they can cut costs to cover the increased tax. Let’s see what happens with each situation.

In the first option, the business decides to take a hit to its profits and simply eat the increased tax. This lowers profits and in a perfect market, the price of the stock is lowered to compensate for the fact that shareholders will receive less profit because more is going to the government. The lowered stock price hurts the individual investor, not the corporation itself. A private business works the same way. The owners of the business will realize less profit and therefore will have less income generated by the business. In the end, it’s the individual owners that take a hit.

In the second option, the business decides that it can raise revenues to cover the tax. How is it going to do this? By raising prices. Let’s take the example of Halliburton, a favorite of the left. Halliburton decides it is going to raise prices to compensate for the tax. It charges the oil companies more for its services in order to raise the revenue needed to cover the tax. The oil company will then raise its prices to not only cover the increased cost of business from Halliburton but to also cover its raised tax liability. So, now the tax increase is priced into oil twice. The refiner buys the oil from the oil company. It has to raise prices to cover the increased cost of the oil and the increase it sees in tax. Now the tax increase is in the fuel three times. Your local gas station buys fuel from the refiner. The gas station has to now price the fuel it sells to you for its cost plus the effect the tax has on them. The loser? The consumer that buys the fuel. The consumer has to pay for the increased cost at each step because the tax was raised. None of the business entities themselves are hurt. If one of the steps in the chain decides to not pass along the increase in cost, we’re back to scenario one and the individual owners of the firm bear the tax.

Now, let’s take a look at the last scenario. If a business wants to cut costs in order to cover the tax, what is the highest cost for most firms? Bingo, wages. The way most businesses would recoup the tax is through lower wages. Whether it is not hiring that next person, lowering annual pay increases, or cutting jobs entirely, wages would likely be lowered to offset the effects of the tax. It’s not hard to see who bears the true burden of the tax in this scenario.

Politicians like raising business taxes because they can use populist slogans and claim that they are not raising your taxes, just evil businesses that don’t pay their fair share. Next time you hear that claim, think about it twice before joining the chorus.