Unexpectedly Intriguing!
June 23, 2011

What are the unintended consequences of taxing U.S. businesses so much more on their payrolls than their corporate incomes?

Corporate vs Employer Payroll vs Combined Taxes as a Percent Share of GDP, 1960-2010

This isn't necessarily an intellectual exercise - this is something that has been the case since 1978, when the amount of taxes paid by U.S. businesses first began regularly exceeding the amount of taxes they collectively paid on their business incomes.

Yesterday, we hypothesized that U.S. businesses would respond by shifting jobs outside of the United States, since that would be the most likely way they could preserve their revenues while avoiding the employers' portion of U.S. payroll taxes.

Today, we'll go a step further - we'll hypothesize that the jobs that would most likely be displaced in this way would most likely be in manufacturing. The reason why is because manufacturing is something that isn't necessarily location specific, as most service type occupations are.

For example, it doesn't really matter much where your mobile phone is manufactured - it could be in Europe, or Asia, here in America or in Africa for that matter - no matter where it might have been produced, it will still be the same mobile phone.

By contrast, the service occupations that support your mobile phone will be location specific. You can likely easily find local outlets for your service provider, which must be fairly close to where the customers for mobile phone service are.

To find out what's happened since 1978, we've created a chart showing the number of people who have been recorded as being employed in manufacturing in the United States from 1960 through 2010 (indicated on the left scale), against which we are showing the amount of U.S. direct investment abroad over the same period (indicated on the right scale), which indicates how much American businesses have invested in places other than the U.S.

Since that money has gone outside of the U.S., we're showing that value as a negative quantity. Aside from that, we've scaled our chart so that the numbers of manufacturing employees and the amount of U.S. direct investment abroad for 1978 are close to each other on the chart, and then we adjusted the vertical scales so that the horizontal gridlines on both scales would line up. Here are our results:

Unintended Consequences of Having Payroll Taxes Higher than Corporate Income Taxes, 1960-2010

What we observe is that when federal payroll tax collections on businesses were lower than corporate income taxes, the number of Americans employed in manufacturing generally rose.

After 1978 however, as federal tax collections on U.S. employer payrolls have steadily risen to become the dominant form of taxation on U.S. businesses, the number of manufacturing employees has generally fallen. We see that there appears to be somewhat of a correlation between the two data streams.

There's more to it than just taxation however, as is pointed out in Andrew Butter's insider look, which is absolutely essential reading, at what other factors induced U.S. manufacturers to move out of America. We'll simply observe for our part that the disproportionate taxation of U.S. businesses on their payrolls would provide an ongoing financial incentive to drive such a change.

Data Sources

Bureau of Economic Analysis. U.S. International Transactions Accounts Data. Table 1. U.S. International Transactions [Millions of dollars] - Line 51. Release Date: March 16, 2011.

Federal Reserve Bank of St. Louis. All Employees: Manufacturing (MANEMP), Thousands, Monthly, Seasonally Adjusted. Accessed 19 June 2011.

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