Apr 29 2011

Does the GE hoax give clue about tax incidence?

Posted by: Nicholas Shaxson in: Thoughts

One of the big arguments that’s been around for as long as I’ve been paying attention to these things – for much longer than that, I think – is the question of where the ‘burden’ of corporate taxes fall. Corporate lobbyists and some economists argue that the burden of the corporate income tax falls mainly on workers (with the subtext, you see, that the tax is therefore pretty pointless.) Others such as the Institute for Taxation and Economic Policy (ITEP) in Washington argue the opposite. The U.S. Congressional Budget Office (CBO) takes a middle position and says that it is ‘unclear’ where the burden of taxes falls.

How does one test where the burden falls, in practice? You can’t test this by looking at how share prices react when companies announce their tax payments. This is partly because these announcements tend to come bundled up with a bunch of other things, which make it impossible to unpick the causes of share price reactions into their component parts – but also because quite often, investors know what is coming in advance, so the reaction is often priced into the stock, ahead of the announcement.

But a few weeks ago, something happened that might constitute an interesting experiment in whether the burden of taxes falls on shareholders (that is, capital owners) or on ‘workers.’

On April 13th, stunt-masters The Yes-Men and the protest movement US Uncut got together and issued a hoax press release, taking great pains to make it look as if it came from General Electric, stating that that the company would voluntarily pay the U.S. government a $3.2-billion tax “refund” as an act of contrition. This followed a hard-hitting New York Times story noting GE’s zero tax bill – a tax benefit, in fact — after earning worldwide profits of $14.2bn.

The Associated Press, and a number of others, picked up the hoax as if it were real, and the story was, in this sense, ‘live,’ for up to half an hour, before word got around (initially via a Reuters story) that it was just a hoax.

The point here is that this brief episode might qualify for our incidence experiment. It came right out of the blue, and other factors such as profits announcements and so on, were stripped out.

So what happened? Marketwatch provided this analysis:

“CEO Jeffrey Immelt was purported to have informed the White House the company would be “gifting” a $3.2 billion federal tax refund to Uncle Sam on April 18, Tax Day .

And did shareholders take a hit?

GE shares fell 1.6% from their preopen high. Not a huge move, but enough to briefly trim GE’s market capitalization by nearly $3.5 billion.

In other words, they said they would give up $3.2 billion in taxes, voluntarily – and the shareholders took a hit to the tune of just about the same amount, before sanity, and the share price, were restored.

Can one conclude from this that the shareholders, conscious that they wouldn’t be able to palm the burden those extra taxes off onto workers, clearly recognise here that they are the ones to bear the burden of this tax?

Well, in a word or two, not really. There could well have been other factors at play there (though I couldn’t find any other obvious specific news during that short time window.)  They might well have factored in not just the taxes, but the prospect of a new approach to taxes from GE, suggesting that shareholders only bore some of the burden, to the tune of $3.5 billion, from a potentially bigger long-term hit. It may well have been simple, loopy, shareholder irrationality. So this episode certainly doesn’t prove any argument that the true burden of corporate income taxes falls on shareholders rather than workers.

But it does provide some interesting anecdotal support for the idea.

More from the battlefield of corporate taxation here.

8 comments so far

AlienEdouard 4th April, 2011 10.29 am

Nick – your line of reasoning is about spurious as it gets.

The pre-hoax GE share price reflected all information available to market participants, including how the burden of corporate tax (past and future) is to be shared between shareholders and other stakeholders, including employees.

The hoax document said that GE would take an ADDITIONAL corporate tax charge with respect to a past period, INCREMENTAL to that already incurred by its various stakeholders. Since it is impossible to adjust wages and benefits already paid to employees, prices already charged from customers or terms already granted suppliers, the impact of the ADDITIONAL charge could only be carried by the shareholders.

Your calculations have simply confirmed that financial markets are extremely efficient at processing new information and to apply it to asset price discovery. But we knew this already. Eugene Fama and others have been writing about it since the 1960s. You are a little late at that party.

It says nothing about corporate tax incidence.

Nick Shaxson 5nd May, 2011 8.37 am

AlienEdouard this is probably the most coherent and interesting reply I’ve had to this argument so far. It’s wrong, though. A company’s share price is supposed to reflect future cash flows to investors: it’s a forward-looking measure, and it’s supposed to be a long-term measure too. It is quite possible, in the long term, to adjust wages and benefits already paid to employees and so on. So thanks for that, but I think my theory (although it’s not even really a theory, just an interesting observation) is now just that little bit more robust.

[…] Shaxson has written the following on the Treasure Islands blog. I thought his analyusis fascinating, valid and almost certainly understated. So, with his […]

AlienEdouard 5nd May, 2011 10.19 am

Nick – I cannot read my own comment. Something is wrong with your moderation function.

Regarding your reply, you are correct that share prices discount expected future cash flows to shareholders. But you are wrong in your conclusions because you miss my point, which is that the hoax document implied an immediate additional, previously unexpected, outflow for the company (in the form of the tax refund being “gifted” to the IRS) which could not be “shared”, ex-post, among stakeholders and was going to hit exclusively the shareholders. Since that cash outflow was going to take place almost immediately, the impact on the share price was going to be in a ratio of 1:1.

You raise an interesting hypothesis that the movement in share price could (also) have reflected the market participants’ revised assumptions regarding the future distribution of the corporate tax burden, or of a shift in strategy regarding tax generally.

Both assumptions are interesting, but intellectually fallacious. Both would assume that shareholders retain managers and directors not committed to value maximization for shareholders, choosing to not minimize the impact of corporate tax on shareholders. Essentially, these assumptions require shareholders to use their governance rights against their best interest. Try hard as you want, it does not work.

How market participants could even start to BELIEVE the hoax is beyond me, but that is for another thread.

I note that Murphy has re-posted your entry and is completely losing it when another observer there raises a similar observation to mine (which Murphy probably does not understand). You are at least you seem to be able to understand the issue even if you reach misguided conclusions.


Nicholas Shaxson 5th May, 2011 2.02 pm


Money is fungible, in a time-related sense, so I think that your nitpicking on this point is, well, pointless. If they can always pass those costs onto workers, why can’t they do so in the future? I think your reasoning is really weird.

And as regards your “try hard as you want, it does not work” – what you are saying, essentially, is “my pet theory says you are wrong, so you must be wrong.” I am saying that your pet theory is wrong.

And it is wrong. Corporate managers aren’t infallible: there are countless things preventing them passing all the costs of taxation onto workers, such as employment rules, unions, the need for good morale inside a corporation, the difficulties and costs of setting up alternatives in other jurisdictions – and on and on. Shareholders have to take a lot of the hit: there’s no way around it. And this example may show – and I stress only “may” – that they sometimes swallow pretty much the entire hit.

AlienEdouard 5th May, 2011 6.56 am

Nick – The point about the time-related fungibility of money is well noted, but it is irrelevant (my initial comment a little vague and could have been worded more sharply). The real issue is around the voluntary and incremental nature of the tax “gift”.

Immediately before the hoax, the GE share price assumed that the company, through the actions of its directors, was trying to minimize (note minimize, not eliminate) the impact of corporate taxes on its shareholders, including by passing as much of the burden to other stakeholders as possible. The hoax, taken at face value, blew this assumption open.

With respect to incidence, two anaytical avenues presented themselves. Number one is that it was impossible to pass on the impact of the “gift” to stakeholders. From the perspective of shareholders it meant not only that they were out-of-pocket but also that they had a management that was deliberately acting against their best interest.

Number two is that the burden of the “gift” could potentially be passed on to other stakeholders, mostly employees. But this begged the question as to what type of new concession(s) the management had suddenly discovered they could extract, and why these concessions had not been negotiated and implemented earlier. Again, it indicated that the management had historically not acted in the shareholders’ best interest. Against this background it would be rational for market participants to heavily discount the management’s ability or willingness to actually pass on the burden of the “gift”.

Under either alternative, the shareholders were left with two problems: the burden of the “gift” and an unanswerable management. The first is relatively easy to quatify, but I have no idea how market participants would have estimated the cost of firing and hiring a board and executives, or would have priced the added uncertainty.

Nicholas Shaxson 5th May, 2011 8.37 am

I think you have now taken to essentially repeating your arguments, but in different ways. And they still don’t work, I’m afraid.

Nicholas Shaxson 5th May, 2011 11.01 am

Oh, and, I’m not sure how this story here from the FT – one among millions of such stories – stacks up against your argument:

“The owner of British Gas on Monday also said that the higher tax rate would cause 2011 earnings to grow “at a more modest rate than anticipated”.

The shareholders take a hit. If the company could pass it all onto employees, then they wouldn’t, would they?

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