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Krugman Just Made A Facepalm Worth Mistake Over Tax

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Paul Krugman’s a very bright buy but he can – just like anyone else – fall prey to wanting to believe what ain’t quite so. Because the implications of what is being believed accord so nicely with either other beliefs or desired actions.

You know, the schoolmaster who does like beating young children will find reasons why corporal punishment is beneficial to them – the children that is.

Here the mistake is to miss what Kim Clausing at least had the good grace to agree could be the real solution. She did a paper which showed that, well, actually you neoliberals, companies did not change their investing dependent upon the tax rates they had to pay. The thing is, she did so by looking at corporations investing through offshore centres and then seeing how their behaviour changed when the actual host economies – the ones invested in, through the offshore centres – changed their taxation laws. She found no effect.

When the paper came out I pointed out to her – and she agreed that it’s a possible explanation, whether it’s true or not is an empirical finding to be found – that precisely because she was looking at investment though tax havens that explained her finding. If people are already successfully dodging taxes then changes in the rates of taxes they don’t pay isn’t going to change their behaviour, is it?

At which point, Krugman:

It didn’t happen. In fact, the tax cut had no visible effect on business investment, probably because it was addressing a fake problem. U.S. corporations hadn’t been moving jobs overseas to avoid taxes; they had just been avoiding taxes.

The true impact — or actually lack of impact — of profit taxes on business decisions becomes obvious if you look at where corporations report big overseas earnings.

If they were truly responding to taxes by making large foreign investments that eliminated American jobs, we’d expect to see a lot of their profits coming from major production centers like Germany or China. Instead, more than half of the profits U.S. corporations report from overseas investments come from tiny tax havens, including places like Bermuda and the Cayman Islands where they have no real business at all.

By the way, this isn’t just an American problem. The International Monetary Fund estimates that about 40 percent of the world’s foreign direct investment — basically corporate cross-border investment, as opposed to “portfolio” purchases of stocks and bonds — is “phantom” investment, accounting fictions set up to avoid taxes.

Our evidence that corporations don’t react to corporate tax rates is based upon people not changing their behaviour when the taxes they don’t pay change. This is not a convincing evidence base.

In fact, we should look at this the other way around. Corporations are sensitive to corporate tax rates. Why would they go to all that fuss to avoid them if this weren’t so? Sure, sticking the brass plate in Bermuda is easier than moving the factory or the customer base but it is still true, the existence of the office in Hamilton is all the evidence we need that they care at least a little bit.

And if they do care about tax rates then we’ve got to be rather careful about changing those rates, don’t we?

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