CHI faces a 30 percent corporate tax that applies to its
economic profits of $400 000, it will pay $120 000 in corporate
taxes, and it will still have after-tax economic profits equal to
$280 000. Since CHI is still earning positive economic profits—
that is, it is still earning more than it could earn elsewhere—it
has no incentive to leave this industry.
In fact, the firm has no incentive to do anything differently than
it was doing previously—the tax on the firm’s economic profit
has no effect on the firm’s output, prices, employment, or long-
run investment choices. Before the tax, CHI was making output,
employment, price, and investment decisions to maximize its
(economic) profits. With the tax, some fraction of these
economic profits must be paid to the government, but CHI still
chooses to maximize its profits by doing whatever it was doing
before the tax.
The implication is that if the corporate income tax applies to
economic profits, firms and their owners bear the entire burden
of the tax. But the tax will have no effect on the allocation of
resources, and in this sense the tax would be efficient.
A Tax on Accounting Profits
Now consider the alternative case in which the corporate
income tax applies not to economic profit but to accounting
profit. CHI’s accounting profits are $1.5 million, which are
greater than (and include) its economic profits. If CHI faces a 30
percent corporate tax on accounting profits of $1.5 million, it