The Hidden Cost of Raising Corporate Taxes

Consumer spending falls — and vulnerable families take the biggest hit

Given that two-thirds of the U.S. economy is driven by consumer spending, policymakers have a clear incentive to consider the impact of any proposed tax changes on household spending. 

While individual tax rates are an obvious concern, a working paper suggests that consumers are hurt when corporate tax rates are increased.

University of California-Riverside’s Eric Allen, UCLA Anderson’s Henry Friedman and Chinese University of Hong Kong’s Yiyuan Wang and Yuqing Zhou studied the impact of state-level changes in corporate income taxes between 2004 and 2019 on household consumption. They estimate that every percentage point increase in a state’s corporate tax rate was associated with a 0.5% decrease in consumer spending. The decline in spending emerges in the year the tax rate rises, and the research finds the hit to spending persists in subsequent years.

Past research has established that when corporate tax rates rise, businesses often react by raising prices, cutting wages — especially for lower-wage workers — and reducing investment, which can lead to less job growth. This research offers evidence on how those corporate responses to a higher tax rate may impact consumer spending.

Notably, the authors found no trickle-down benefit to consumers when corporate tax rates are lowered. The researchers observed no significant change (increase) in household or statewide consumption when corporate tax rates fall, suggesting companies may keep the savings rather than passing them on to workers or consumers through higher wages or lower prices. To the extent any savings from lower tax rates are shared, the researchers suggest it may be with investors, via increased stock buybacks or dividend payouts.

Less-Advantaged Hit Hardest

The researchers tracked household shopping behavior using data from NielsenIQ’s Consumer Panel, which has detailed spending data on between 40,000 and 60,000 U.S. households each year. The study ended in 2019 to avoid the economic distortions of the COVID-19 years. On average, a household spent $7,790 annually on consumer products tracked by NielsenIQ — things like groceries, household goods and personal care items, but not housing, transportation, education, health care or other services. The researchers combined this household spending analysis with state-level consumption and tax revenue data.

During the 15-year study period eight states raised their corporate income tax rate and there were more than 70 reductions in corporate tax rates among multiple states. The researchers used household spending data from states with no changes in corporate tax rates as their control groups when analyzing spending patterns in states that raised or lowered their corporate tax rate.

While the average impact of a 1 percentage point increase in a corporate tax rate was a 0.5% decline in household spending, the impact was harsher for families that lacked savings to absorb higher prices and/or reduced wages, or that didn’t have the academic credentials to seek out a better job (or negotiate a better salary).The researchers observe that:

• When corporate taxes increased by 1 percentage point, households headed by parents without college degrees reduced spending by an additional 0.7% compared with college-educated households. 
• Nonwhite households cut consumption by an extra 1.1% compared with white households facing the same tax increase. 
• Families with limited financial cushions — measured by how much of their budget goes to necessities like food — reduced their spending by an additional 0.5% compared with families with more financial flexibility

This adds a new variable — rising corporate tax rates — driving economic inequality, as less advantaged households must cut back more significantly than better-off households. 

States Feel Pain, Too

The economic consequences of higher corporate taxes ripple beyond individual households. The research shows that a 1 percentage point corporate tax increase is associated with a 0.2% decline in total state-level consumption, and, interestingly, a 0.23 percentage point reduction in a state’s net migration rate. That suggests that as businesses react to higher tax rates by potentially raising prices and/or lowering wages, it not only impacts the state’s finances — tax revenues fall, which eventually may reduce public services — but it seems to also reduce job opportunities given the weaker net in-migration.

The impacts identified by this research complicate how states can best generate needed revenue to deliver services. While corporate tax increases may seem like a politically safer way to raise revenue without directly hitting consumers, the evidence shows these taxes do hurt household spending — and hit vulnerable families hardest.