London, 30th April 2021

In a recent article in the New York Times (Why Was Trump’s Signature Policy Such a Flop? 9th April 2021.) Paul Krugman asks a good question to which he gives the wrong answer. When Trump’s cut in corporation tax was announced I wrote that it would have little impact on business investment, because this would continue to be depressed by the bonus culture. I sent this to Sam Fleming, then the FT Correspondent in Washington, with copies to other FT journalists (Rob Armstrong, Alan Beattie, Chris Giles and Martin Wolf) and I attach a copy to the end of this paper.

I have recently written a paper which shows that corporation tax is a tax on investment and that plans to raise its level in the UK and the US would badly damage those economies, but importantly that a tax credit for tangible investment would, if made permanent in the UK and introduced in the US, be beneficial. This can be accessed here.

Corporation tax is a tax on investment, but it is not the only reason why investment fluctuates. All that we know is that rises in its rate will depress business investment and cause growth in output and labour productivity to be slower than they otherwise would be. US corporate investment has risen since 2017 when the rate was cut, but the extent disappointed many economists.

Paul Krugman dismisses the idea that corporation tax deters investment, claiming that “…most business assets are fairly short-lived. Equipment and software aren’t like houses, which have a useful life measured in decades if not generations. They’re more like cars, which generally get replaced after a few years — in fact, most business investment is even less durable than cars, generally wearing out or becoming obsolete quite fast.”

But corporate business capital is long-lived. As I show in Chart 1 below the average life of the assets created by corporate investment is 16 years.

The second pillar of Paul Krugman’s argument is that “And the profit tax is at this point largely a tax on monopoly or quasi-monopoly profits. Officials I’ve spoken to cite estimates that around 75 percent of the tax base consists of “excess” returns, over and above the normal return on capital, and that this percentage has been rising over time. Loosely speaking, this means that most of a corporate tax cut just goes to swelling monopoly profits, with any incentive effects limited to the shrinking fraction of corporate income that actually reflects returns on investment. That I.M.F. study of the Trump tax cut suggested that rising monopoly power might help explain its lack of impact.”

For profits to have been boosted by an increase in monopoly, they would have to have been accompanied by a rise in the profit share of output. But as I show in Chart 1 of my paper, the profit share of US corporate output is currently at its long-term mean reverting average level and has fallen over the past 6 years.

The cause of the weak response of US corporate investment is due to the perverse incentives of modern management remuneration as I explained in Productivity and the Bonus Culture (Oxford University Press 2019).

Full response: Response to Paul Krugman on Corporation Tax [April 2021]