Simplistic Thinking on Corporate Taxes

It’s a boring cliche that firms are relocating from California to Texas because of the punitive corporate taxes.  Nevermind that this doesn’t really seem to be true – after all, nobody sane thinks Google is about to relocate.  And in more narrow empirical terms, it’s clear that there’s no boundary effects between California and Nevada, which has no corporate income tax.  It’s clear that firms prefer to locate in places where they can attract skilled and productive employees, and that corporate taxes are a much less important confirm.

More fundamentally, I would have thought the principal-agent theory should kill this argument stone-dead.  Keep in mind that decisions about firm location, especially in public firms, are made by corporate management.  On the other hand, corporate profits go to shareholders who do not exercise direct control of the firm.  Corporations only pay corporate taxes on profits, not revenue.  The main difference between revenue and profit is, of course, employee compensation.  Corporations don’t pay taxes on the money that goes to their employees.

So…at the margin, firms should actually prefer high corporate taxes.  The higher corporate taxes are, the less money goes to shareholders for every dollar of profit.  Therefore there’s less incentive to keep employee salaries to a minimum, including of course executive salaries.  You should expect management to prefer to locate in high-corporate-tax regimes in order to maximize their own salaries.

So..yes, “incentives matter”, but not always in the pat way in which people talk taxes.

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