Does the Welfare State undermine economic competitiveness? No, just ask Ford.

There’s been a great deal of debate in the presidential campaign about the role of taxes.  McCain has argued that the United States has the highest corporate taxes rate in the world, and that companies are therefore driven out of the United States searching for better opportunities in lower-tax countries.  Obama has argued that smart taxes are the way to go, using tax policy to promote investment in new sectors, such as green energy.  As is often the case in politics, both sides overstate the strength of their own arguments.  McCain is correct that the United States officially has one of the highest corporate tax rates in the world…but due to the effective use of loopholes, deductions, and tax credits, few corporations actually pay that tax rate.  And Obama’s plan to use tax incentives to create green jobs sounds promising, but it remains to see if it could be effective.

All of this raises questions about the role of the state and the impact of taxes on corporate decision making.  And here, the relationship is less clear than is often assumed.  It seems obvious that corporations will relocate to countries where taxes are low.  Yet if this were true, we’d expect a flood of companies relocating to tax havens.  In reality, we see very little of this.  Why? 

There are two reasons.  First, capital is not as mobile as is often assumed.  Companies do relocate, but they cannot relocate anywhere.  And relocation costs money. 

Second, and more importantly, taxes are just one of a number of factors that influence corporate decision making.  Indeed, corporations may sometimes choose to relocate to higher-tax countries in exchange for other benefits.  In 2005, for example, Toyota chose to build a factory in Canada rather than in the United States because, despite having to pay higher corporate taxes, the Canadian health care system reduced corporate expenses for health care.  U.S. auto manufacturers have long complained that worker health care costs are undermining their global competitiveness.  According to some estimates, General Motors pays an average of $1500 per car to cover the cost of health insurance for its employees.  For Ford, its $980 per car.  Not surprisingly, workers health insurance costs have been at the centre of union contract negotiations for all major U.S. auto manufacturers.  German and Japanese auto manufacturers do not have to pay these costs, which are instead borne by the government.

This specific example is confirmed by more general studies.  The World Economic Forum, an independent organization which provides global discussions among the world’s business leaders, produces an annual Global Competitiveness Report, in which it ranks the business environment in countries around the world.  If low taxes were the driving force for corporate investment decisions, we would expect the countries with the lowest taxes (and therefore the lowest level of social welfare services) to be the most competitive.  The results?  Not even close.  According to business leaders, the most competitive countries in the world are:

1. The United States
2. Switzerland
3. Denmark
4. Sweden
5. Singapore
6. Finland
7. Germany
8. Netherlands
9. Japan
10. Canada

Hardly a list of low tax havens!  Clearly, other factors must enter into the decision.  In the real world, it appears, corporations are willing to operate in countries with higher marginal tax rates (e.g., Denmark, Sweden, Finland, Germany, the Netherlands, and Canada) when there are social welfare benefits associated with higher taxes.  Corporations, just like people, expect something for their tax money.

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