This essay is a response to two Op-Ed pieces from this morning, one by Larry Kotlikoff in the New York Times called Abolish the Corporate Income Tax, the other by Larry Summers in the Washington Post called Strategies for sustainable growth. While I agree with both of them regarding goals, I disagree on the proper cure, as both seem to treat capital liquidity as an immutable constraint.
Kotlikoff, for example, talks about Boeing's negotiations with its machinists and the credible threat for Boeing to locate future plants away from the Seattle area (in the southeast instead) as a way to get concessions from labor. Since capital flows much faster than labor migrates, this type of threat grants bargaining power to capital, and can lead to inefficiency when the threat is carried out (see below). It would be be better if costs were imposed externally, via regulation or taxation, to lessen this sort of threat.
Summers mentions a different problem - asset bubbles. He argues, and I agree with him on this, that given the low (negative real) interest rate policy being pursued by the Fed, bubbles are apt to be an unintended consequence. There is no denying that bulls will rush in on occasion. But that they do so seeking short term gain only, which is present because of speculation and untoward lending practices, quite possibly leaving long term devastation in the aftermath, means the bulls should be discouraged from making their charge. As in the Kotlikoff example, taxation or regulation to lessen the likelihood of the behavior should be welcome.
Here's the microeconomic analysis of the siting decision for a large-scale economic activity, when the economic actor making the decision has some market power. The decision will be made by considerations of profitability. But, in theory, the decision should be made on the basis of net social benefit. The two are not the same. Here is a simple and clear-cut example to illustrate.
The NBA basketball franchise that used to be in Seattle is now in Oklahoma City. This move was profitable for management to make, as I'll explain in a moment. But it clearly was inefficient, as can be seen from this table of Metropolitan Statistical Areas. Seattle is 15th on the list while Oklahoma City is 42nd, and with less than 40% of the population of Seattle. Why did the team move? The team needed a new arena (or a major upgrade to the old arena) and the issue was who would pay for it, the team or the municipality? Note, however, that given the arena (or major upgrade) will be built, who pays for it has no impact whatsoever on net social benefit. But it has a huge impact on the team's bottom line. In this particular case the municipality of Oklahoma City agreed to upgrade Chesapeake Energy Arena. That's all she wrote.
Indeed one might argue more generally that there are too few franchises in the major professional sports and owners deliberately do this as a way to encourage that the costs of facilities replacement be put on taxpayers in the municipality rather than on the teams (thereby making the teams more profitable). If the municipality tries to push back on this and asks the team to foot the facilities upgrade bill, the team will threaten relocation and if the subsequent negotiation goes poorly the team will actually move.
The same economics is at root when a company the size of Boeing threatens to relocate its production facilities from a union state (high wage) to a right to work state (low wage). On the net social surplus calculation, these moves are probably bad. The calculations entirely discount the specific human capital of the current work force, the relationships with local input suppliers, the complementary businesses that have emerged as a consequence of the Boeing presence, and that Seattle has become a place where people want to locate in no small part because Boeing is there. All the calculations focus on is the company's bottom line. Even if Boeing stays, as Kotlikoff points out, labor must give concessions to ensure that outcome so this represent a transfer of income from labor to shareholders (or to upper level management). If, contrary to fact, it cost the company a substantial amount to make such a move, because of regulation or taxation, labor would not have to concede so much.
During the Republican Primaries in 2012, Governor Perry made an issue of the growth rate of jobs in Texas versus that of Massachusetts, which highlights that politicians don't understand the economics of siting production. Perry made a specious argument to the effect that low tax states grow jobs, not distinguishing at all between fundamentally new economic activity and economic activity that would occur in any event but that would be sited in places where it is taxed less. To the extent that Texas has had the latter, accompanied by inadequate public infrastructure, precisely because tax revenues are too low, that is a problem, not a model to emulate.
Similarly, on the international front, before the housing bubble burst Ireland was cited as a model for the new Europe - a low tax, low regulation haven for business. The Irish economy grew very rapidly in that period. But when the housing bubble burst, the Irish economy was hit hard, because many in the private sector were highly leveraged and the growth had stopped. Business pulled out. Looking at the full experience, the low tax approach appears far less attractive.
It's amazing to me that we haven't learned from these experiences. What we should want is not a quick fix to short term growth, but rather that regional and national differences in tax and regulation policy be minimal so they become non-factors in the siting of economic activity. And we should want further frictions to encourage inertia of capital. If market fundamentals otherwise indicate that capital should flow to where it is more productive, that will happen in due course. Our mistake is wanting to speed the flow along. All that has done is to create havoc.