Unveiling the Corporate Tax Burden: How Corporate Taxes Impact Consumers

How do corporate taxes influence consumers? Do consumers actually pay part of the corporate tax? A comprehensive study by TRR 266 researchers Martin Jacob (WHU – Otto Beisheim School of Management), Maximilian Müller (Cologne University) and Thorben Wulff (WHU – Otto Beisheim School of Management), recently published in “Contemporary Accounting Research”, investigates these questions by analyzing gas prize data from Germany. They show how tax policies that increase effective corporate tax rates may have unintended consequences for consumers through higher prices.

There is a prevailing assumption among policy-makers that the burden of corporate taxes falls on firm owners and employees rather than on consumers. The Joint Committee on Taxation, for example, assigns 25% of the corporate income tax burden to labor and the rest to firm owners. But, is this really the case? Our research findings challenge this notion and shed light on how higher corporate taxes can lead to increased consumer prices.

In our study, we focus on Germany’s retail gasoline market as there are large differences in local business tax rates and detailed price information available. Our sample includes data from approximately 15,000 gas stations and 4,474 German municipalities. In Germany, each municipality can set its own local business tax rate. These rates vary between 7% and 19.25%, which is significant compared to the 15% federal corporate tax rate. We want to understand how these different local business tax rates affect consumer prices.

Consumers bear 64% of the corporate tax burden

Contrary to common assumptions, our research shows that higher corporate taxes increase consumer prices and that consumers bear about 64% of the corporate tax burden. Given the average local business tax amounts to 14%, a substantial share is passed on to consumers. Our analyses show that a one-percentage-point increase in the local business tax rate leads to a 0.1 euro cent per liter rise in gas prices. Although this appears small relative to the average gas price of 1.39 euros per liter (around 5.15 dollars per gallon) of E5 (gasoline with 5% ethanol) during our sample period, it is important to note that roughly 90% of the retail gas price is fixed and margins are thin. Therefore, even this small increase is significant. Our findings extend over several years and indicate an asymmetric pattern: Even though tax increases translate into higher prices, tax cuts do not necessarily result in lower prices.

Influencing Factors

The extent of this tax pass-through to consumers is not uniform, but varies under different conditions:

• Limited tax planning opportunities: Examining various dimensions of tax incidence, we discover that consumers bear almost all of the tax burden when tax planning opportunities are limited or when tax enforcement is stronger. When tax planning opportunities are greater or tax enforcement is weaker, the effect of taxes on prices becomes nonsignificant. In that case consumers bear almost none of the tax burden.
• Debt vs. equity financing: Additionally, the choice of financing—debt versus equity—affects the tax burden as the cost of debt financing is tax-deductible (and thus acts as a tax shield) while equity financing is not. Companies using more debt financing may therefore pass on fewer taxes to consumers. Our results suggest that indeed having other methods to decrease the tax burden, like using tax shields or avoiding taxes, leads to consumers having to bear less of the corporate tax.
• Market power and demand elasticity: Also, how much market power a business has in the market and how sensitive customers are to price changes affect how much taxes impact consumer prices. Gas stations facing less intense local competition and less elastic consumer demand pass on a higher proportion of business taxes to consumers.

Consequences beyond the price tag

Besides higher consumer prices, higher corporate tax rates also influence gas stations’ investment decisions and market presence. Specifically, higher taxes lead to reduced investment and potential exits from the market.

Understanding and navigating tax implications

Our findings help to understand how corporate tax policies affect various stakeholders, not only firms, and have broader economic and societal implications. In the light of recent policy proposals, such as global minimum tax or increased corporate tax burdens, these insights highlight that consumers may pay the price of such initiatives via higher consumer prices. Our study also demonstrates how available tax planning opportunities or other tax shields can mediate the effect of business taxes on consumer prices. This insight matters for both policymakers and business operators in understanding and navigating tax implications. Regulators can use these results to fine-tune tax policies to balance revenue generation with economic stability and growth as well as mitigate unintended consequences on consumers. Business operators gain a better understanding of market dynamics and how corporate taxes can affect their investment, pricing strategies and overall business operations. With this insight, they may adapt their business strategies accordingly.

Avenues further research

Our research offers a robust empirical framework for further study on tax pass-through mechanisms, encouraging exploration of related topics like market power dynamics and tax planning. While our study is focused on a specific market, it opens up avenues for future research to explore the extent to which these findings are applicable in other markets or countries, which could be instrumental in forming a more comprehensive understanding of the implications of corporate tax policies.

To cite this blog:

Jacob, M., Müller, M., Wulff, T. (2024, January 24). Unveiling the Corporate Tax Burden: How Corporate Taxes Impact Consumers, TRR 266 Accounting for Transparency Blog. https://www.accounting-for-transparency.de/how-corporate-taxes-impact-consumers