Who REALLY Pays Business Taxes?

by Brian G. Long, Ph.D, C.P.M..

With thousands, millions, and billions of dollars flowing through the business community, surely they can spare a few extra dollars to help close a government budget gap.  They can afford to pay their “fair share!”   Fine.  But who REALLY pays those additional taxes?  At first glance, the simplistic answer is that businesses pay business taxes.  Granted, the businesses write the checks to the government, whether it’s paid at the state, local, or federal level, and the money is removed from their cash assets and transferred to the respective government treasury.  But the broader question is this:  Who actually BEARS the brunt of business taxes?
Consider a business sector that is a perpetual whipping boy:  The petroleum refining industry.  Let’s assume there is an announcement that the government is now going to slap a tax on every refinery in the country of 10 cents per gallon of gasoline produced so we are sure these oil companies are paying “their fair share.”  Since the U.S. consumes about 130 billion gallons of gasoline every year, it will create lots of new revenue, about $13 billion.   Among the general public, there is a latent assumption that the new tax will simply be a reduction to the profitability of the oil companies.

Unfortunately, this not how it works.

Take Exxon-Mobile, perpetually number one or two in the Fortune 500.  They show HUGE revenues and profits, largely because about 75 percent of their business is OUTSIDE of the US.  In a GOOD year, Exxon makes about 7 cents on a gallon of gasoline.  Let’s assume that all of Exxon’s competitors also make about 7 cents a gallon.  Of that, about two pennies are paid out to stockholders in dividends.  Another penny is banked as “retained earnings,” i.e., a reserve for years that they DON’T make 7 cents per gallon.  But the remaining four cents is REINVESTED back into the company to explore for more oil and gas.  Now, a 10 cent tax will take the whole seven cents in earnings and three cents more.   The price of the stock will fall dramatically, harming almost every major pension fund in the country.  After the existing wells are pumped dry, the company will go out of business.  If this were to happen industry wide, we would either return to the Stone Age or opt to import all of our oil.

In reality, as long as we have a free market, the company will be virtually unaffected.  The government will sit proudly with a new-found $13 billion, but the 10 cents per gallon in new taxes will simply be ADDED to the price of every gallon of gasoline.   Hence, the inescapable conclusion is that the additional tax is almost entirely borne by the END CONSUMER.

OK. So businesses pay the 10 cent tax, or consumers pay the tax.  It’s a wash.  So what’s the difference?  MOST people understand that businesses must make a profit to survive, MOST people understand that companies are formed in anticipation of making a profit.  Not everyone understands that businesses decide where to locate based on the TOTAL COST of doing business, a component of which is taxes, but also includes insurance, energy costs, transportation, regulation, labor cost, labor AVAILABILITY, and many other factors.  Most people DO NOT understand that the net margin for most products sold in the country is really fairly slim.  For groceries, it’s about 1 to 2 percent.  For all of the Fortune 500, the NET PROFIT over time runs about 5 percent.

Take the case of a company that is making a product that is sold around the world.  Let’s assume that ONLY Michigan puts a special 3 percent tax on its product.  In order to produce the product in Michigan, the firm will have to add the 3 percent tax to the selling price.  Just like the gas tax, the new tax is borne by the end customer.  Fine.  But what if the anticipated net margin is only 6 percent?  The Indiana business development recruiters are well aware that taxes are 3 percent higher in Michigan.  Their sales pitch is the business will be twice as profitable if it locates the new plant in Indiana.  If the company builds the plant in Indiana, hires lots of new people, and Indiana begins collecting the other taxes the firm pays to the state and local governments, Indiana wins, and Michigan loses.

Granted, taxes are just one factor used to determine where to locate a business, OR when to CLOSE a business and move it to a more profitable location.  Also, it should be noted that location decisions are not made over night.  A business may bear a new tax for several years before deciding to move.  Conversely, any state or local government that cuts business taxes will not see an immediate building boom.   If a new tax is imposed nationwide, the decision may be made to produce the product overseas.  In the age of global competition, firms in the United States must compete in the world market or go out of business.

The bottom line is simple.  Raising business taxes seldom helps balance government budgets in the long term, and usually result in costing individual taxpayers more, not less.  But a new business tax does make some people feel that “justice” has been served, even if the economic consequences are negative.

Not to be misunderstood, advocating that all taxes be cut to zero is just as spurious.  Granted, many businesses will flock to Michigan in the short term, but there will be no schools, no fire department, no road repairs, no police, and no functional government.  Ideal taxes are a question of balance, as well as a question of competitiveness.  Wise planners know the difference.