Public Finance, 2nd Edition

THE HARBERGER ANALYSIS

Arnold Harberger's 1962 analysis of the incidence of corporate income tax

stands as a landmark without rival in the literature on tax incidence theory.

Its contributions were twofold. In the Wrst place, his study Wrmly established

the fundamental principle that incidence analysis, properly conceived, re-

quires a full general equilibrium model of the underlying economy. Second,

Harberger developed the methodology of measuring incidence in terms of

changes in actual general equilibrium consumer and producer prices, focus-

ing primarily on changes in factor prices. Although, as noted above, this

measure cannot possibly be the deWnitive measure of tax incidence, no other

single measure is infallible either. Many tax theorists have chosen Harber-

ger's method of analysis in their own studies, regardless of the tax being

analyzed. They do so because Harberger's model gives a good intuitive sense

of how the market economy spreads the burden of a tax beyond its point of

impact in determining the incidence of the tax. For all these reasons, Har-

berger's study of the corporate income tax deserves careful attention. It also

happens to be, somewhat ironically, an excellent vehicle for demonstrating

the limitations of the change-in-actual-prices measure of incidence as a

measure of true economic burdens. Thus, it serves as an appropriate conclu-

sion to the chapter.

For his analytical framework, Harberger chose a one-consumer (equiva-

lent), proWtless, perfectly competitive market economy with general, constant

returns to scale (CRS) production technology. His basic methodology can be

stated very simply in terms already outlined in the preceding sections of this

chapter. First, he chose to analyze the incidence of a single ``small'' tax in

which the revenues were returned to the consumer lump sum. SpeciWcally,

Harberger posited a single tax on the use of capital services by all Wrms in one

of two sectors within the economy, the `corporate sector,

15

the proceeds of

which are spent by the government exactly as the consumer would have spent

them. This assumption is equivalent to returning the taxes lump sum, and it

automatically maintains budgetary balance (at level zero) and consumers'

lump-sum income (also at zero with CRS).

16

Once the tax rate is speciWed, all

that is required to determine the resulting price changes is diVerentiating the

market clearance equations of the form:

D

i

pttp

i

pt i  1, ...,N 16:36

where

D

i

demand (supply) for good (factor) i by the consumer.

15

Notice that this is a ``speciWc'' or ``selective'' tax as opposed to a ``general'' tax, since only

a subset of all the demanders of capital is taxed.

16

For a more careful discussion of the eVect of this tax and transfer on the consumer's

income, see page 563.

16. THE THEORY AND MEASUREMENT OF TAX INCIDENCE 549