Corporation Tax and the Harberger General Equilibrium Model Essay

A corporation can be defined as firstly having limited liability, where its owners, the shareholders, are not required to use their personal assets to pay the debts of a failed company; thus the owners and the corporation are separate legal entities. Secondly a corporation has delegated management where the decisions of how the company is run, are left to the managers whom are separate from the owners. Finally the owners of the corporation can easily transfer their share of ownership through the exchanges in the financial markets. The tax on a company’s profits which is the difference between the company’s gross income and its business costs is thus called the corporation tax. Now it may appear that as the tax is on the profits of the company and so the company must pay the tax, however there are many individuals such as the employees, consumers and owners on whom the corporation tax can be passed on too. I will look at the Harberger general equilibrium model, which analyses the incidence of the corporation tax by splitting the US economy into two sectors, the corporate and the non-corporate, which produce goods X and Y respectively. There are several assumptions made in the model which are that there is full employment, and after the tax, if initial prices continue to prevail, then government would just counterbalance the reduction in private expenditure on the two goods. There is also free mobility of factors across sectors, competitive markets and constant returns to scale, as well as a closed economy and free mobility of factors across sectors. It is also assumed that the redistribution of income among consumers will not change the patterns of demand. The analysis by Harberger shows that there are several variables wh... ...us allows for the corporate returns to recover to a point of equilibrium in the long run where the returns in the two industries are at a lower but equal rate. If the results of Harbenger are to be believed, where owners of capital bear the full or close to the full burden of the tax, then there should be cause for concern for countries implementing high levels of corporation tax. This is because there is a global trend for increasingly higher levels of capital mobility. Therefore, owners of capital would be able to somewhat avoid the tax burden by avoiding countries with high capital tax rates, and thus restricting the flow of capital to those countries. However, given the large number of variables which need to be taken into account when determining the incidence of the corporate tax it is still not completely clear who bears the incidence of the corporate tax.