The Tax Series: Taxes and the Business Cycle

Taxes, like all economic measures, follow the business cycle. So much so that it’s interesting to understand past business cycles—and perhaps the current bust—in terms of taxes. Here we examine the yin-yang of corporate and employment taxes by plotting the country's total employment taxes minus corporate taxes.

Employment taxes include Social Security and Medicare taxes and Federal unemployment tax. They are generally paid by an employer on a per-employee basis, so they go up when labor goes up. Corporate income tax is, of course, based directly on how much profit a company makes and only indirectly based on how many employees it has.

Above, we see that over time the overall tax burden has shifted towards employment taxes. In 1960, the two types were about equal, and employment minus corporate taxes were just under $0. By 2007, employment taxes overall were $454 million greater than corporate taxes.

But this is where we see an interesting pattern in the business cycle. Look at the second of the two visualizations. In recessions, (the line is colored red during recession, or periods of negative growth) you see a downward slope-- meaning that corporate taxes are increasing relative to employment taxes. This probably happens because in recessions companies lay off workers and slow down wage increases, so employment taxes fall more than corporate taxes fall.

The opposite effect is also true. When the country has strong GDP growth (dark green lines) there’s a tilt towards employment taxes as businesses hire and workers demand higher wages. These are the boom years.

Here’s another way to look at the business cycle, now colored by the unemployment rate instead of GDP.

Here we see booms and busts as deviations from the trend line.

  • In the recession of 1981-1982 and leading up to it, companies cut back on labor.
  • In the early 2000s, employment taxes outpaced corporate taxes, reflecting the beginning of a boom cycle and investment by companies in labor.
  • In our current investment cycle, employment taxes have stayed relatively flat while corporate taxes have increased-- the so-called "jobless recovery."

The current financial crisis provides an interesting explanation of the jobless recovery. Perhaps the corporate profits, which were so high relative to wages, were artificially inflated-- especially in the finance sector. If we adjusted those profits for the write-downs and bankruptcies of 2008, the unusually high corporate profits (and hence, taxes) of 2005-2007 might not be so high.

Data sources:

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