Business investment decisions are of course complex. Among the many factors that a company considers before deciding where to set up operations, expand, or relocate are a jurisdiction’s regulatory burden, market proximity, labor availability, and transportation infrastructure.
But we cannot underestimate the role that taxes play in these decisions. Two recent high-profile examples are good reminders of how taxes and overall government policies can influence investment decisions.
Roughly two weeks ago, Burger King and the Canadian-based Tim Horton's announced a merger totaling $12.5 billion that was partly motivated by the hamburger chain's interest in moving to Canada to take advantage of a more competitive business tax regime.
The transaction received considerable media and political attention given that it’s part of a trend of American-based companies merging with foreign ones and relocating elsewhere to save on their tax bill and avoid the U.S. policy of taxing global income.
The Obama Administration signaled an interest in curbing this practice and has threatened executive action that would create obstacles to it going forward. But the reality is that the U.S. will continue to lose out as a result of its decidedly uncompetitive corporate income tax rate. As of last year, Canada’s average combined (federal and provincial) corporate tax rate is 26.3 percent compared to an average federal-state corporate tax rate of 39.1 percent in the U.S. The ultimate solution for the U.S. is corporate tax reform that brings the federal rate down closer to its global competitors.
Competition for mobile investment is not just between countries. Tax competitiveness (or a lack thereof) can therefore also influence investment decisions within countries – a practice that the late American historian Daniel Boorstin called “entrepreneurial federalism” whereby jurisdictions (such as Canadian provinces or U.S. states) compete with policies to attract mobile capital.
A major new investment announcement by Tesla Motors is an example of this dynamic in practice. The fast-growing car manufacturer recently announced it will build a new $5.5 billion manufacturing plant in Nevada, choosing the Silver state over a handful of others.
The announcement came after months of wooing by governors across the country (media reports suggest that as many as five states vied for the company’s investment). While the Nevada government sweetened the deal by adding special tax incentives such as property and sales tax abatements, it’s hard to argue that Tesla’s decision to locate the company’s “giga-factory” in Nevada wasn’t motivated by the state’s investment-friendly policy framework – particularly when compared to Tesla’s home state of California.
Nevada's business climate is marked by no personal or corporate state-level income taxes. It is also one of 24 states that have enacted "Right-to-Work" legislation which allows workers to opt out of paying any union dues instead of the partial opt-out available in non-Right-to-Work states.
By choosing to locate its factory in Nevada, Tesla’s decision is another real-life example of how pro-investment and pro-growth policies can position a jurisdiction for positive economic outcomes.
And this should not surprise us. A wealth of theoretical and empirical research on what drives (no pun intended) business decisions finds that corporate income tax rates are an important contributor to a jurisdiction's economic performance. High rates can diminish a jurisdiction's appeal as a destination for business investment and hurt its ability to compete with others for investment and ultimately job creation.
This is because high taxes change the incentives people face. Higher corporate tax rates decrease the after-tax rate of return that investors receive and thus reduce their incentives to invest and grow, leaving firms with less capital to invest in productivity-enhancing machinery, equipment, and technology. Because productivity is a key driver of wages, lower productivity means that workers ultimately suffer.
U.S.-based research also highlights the benefits of Right-to-Work laws. This body of research focuses on the differences between Right-to-Work states, which ban mandatory union dues, and non-Right-to-Work states, which do not. The evidence shows that Right-to-Work states enjoy increased economic growth, employment, and in-migration from other states.
Policy debates can often get caught up in abstract discussions. Yet these two recent transactions should serve as a piercing reminder that in the real-world government policy is a major driver (or deterrent) of business investment. North American jurisdictions should take note and bolster their competitiveness if they want to attract and retain business investment and jobs.
