In a recent blog post, Paul Krugman tried to illustrate a point about the GOP tax cut plan by imagining interplanetary trade with Martians. (At least he’s now entertaining voluntary transactions, rather than an alien invasion.) Yet in his zeal to downplay the potential benefits to workers from a corporate tax cut, Krugman ends up shortchanging the versatility of markets. As a teaching exercise, I’ll walk through the full implications of Krugman’s story about Martians, to show the elegance of capitalism.
Krugman’s Martian Scenario The context for Krugman’s fanciful thought experiment is the GOP plan to cut the corporate income tax rate from 35 to 20 percent. In order to sell this plan as pro-worker, the GOP defenders are arguing that capital is very mobile on the international market. Therefore, global investors can be picky, and must earn the same after-tax rate of return (due account being made for risk), wherever they invest. This means – so the GOP argument continues – that a large cut in the US corporate tax rate will simply invite a flood of foreign capital into the US, pushing down the pre-tax rate of return to reestablish equilibrium across all countries. Yet this process helps American workers, who are now mixing their labor with a larger capital stock. Because labor productivity is higher with more tools and equipment, wage rates end up rising. Thus, so the argument concludes, the primary beneficiaries of the GOP tax cut won’t be international capitalists, but instead will be American workers.
As you can imagine, Krugman has been doing his best to throw cold water on this chain of reasoning. One line of attack has been the casual assumption that a flood of new foreign investment could come into the United States and quickly increase the capital stock, in order to push down the earnings of capital (while raising the earnings of workers). Krugman argues that because global markets are not fully integrated, that the adjustment process could take decades, meaning that workers would have to wait a long time to see the alleged benefits from the big tax cut on corporations.
This post was published at Ludwig von Mises Institute on 11/22/2017.