Monday, November 21, 2011

Competing on Corporate Taxes

This is an unusually nerdy post, so if you're not into economics, skip it.

I'm going to briefly discuss why it's unnecessary for the U.S. to compete with other countries on corporate tax rates.

Imagine you're running a country. Let's just focus on maximizing good for the long run first, then talk about short-term effects. The basic principle is that in the long run, the exchange rate will change to make your imports equal your exports. Now let's say that a company moves a plant from the U.S. to China. Presumably, they can produce, say, product A, more cheaply in China than they can in the U.S. That means that the resources (labor, etc.) that would have been used to produce product A can be employed elsewhere in the U.S. economy. Assuming that those resources can produce a product B, which is close to the value of product A, and product A can now be produced more cheaply, productivity has increased. If many things begin to be produced in China, such that China is exporting more than it imports, then the value of China's currency will increase until imports again equal exports. Now, realistically, China holds down the value of their currency by buying tons of our currency and stockpiling it. That basically means they're making their stuff artificially cheap: they're exporting products, we're exporting money (which we can freely print). So if they do this for the long-term, we're the winners, because we're getting the goods and services without having to produce anything. If this is done in the long-term, it doesn't create U.S. unemployment because wages will adjust to create full employment.

Now, let's consider the short term. During a recession, aggregate demand is too low, and it needs to be increased. Suddenly having a weak currency is very desirable because it increases the attractiveness of your goods overseas, and can increase your exports. That's why when we hit the recession, all of a sudden everyone is mad at China for keeping their currency weak. It wouldn't matter during normal times, but during recessions, everyone wants to be the ones with the weak currencies. Getting companies to build plants in your country is suddenly important because it increases expenditures. But it's important to realize that it's only important during a recession, not during normal times. So a temporary tax discount to get companies to come here makes sense right now, but long-term dropping of corporate tax rates to "compete" with other countries does not.

Economics is awesome.

1 comment:

Dad said...

Good explanation. It seems the objective is to have jobs for your citizens. And the higher paying the better. I think a lot of the economic frustration is that some countries have such low labor rates that we really don't want to compete against them. Interesting how economies adjust. The cost of goods in Australia or Europe is typically much higher than in the US.

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