Such a tax change also causes a sharp reduction in the number of people who work at all, and causes many others to join the underground economy (see Chapter 2 ), or to devote their time to tax evasion. Overall, then, higher tax rates cause lower output and higher unemployment. Wealth is reduced now and in the future.
Taxes also affect the incentives to invest. A good case in point is Ireland, whose economy in the 1980s was a disaster, and whose citizens were among the poorest of European Union (EU) citizens. In the 1990s, the Irish slashed the corporate profits tax to 12.5 percent, the lowest in Europe and only about one-third as high as the U.S. rate of 35 percent.
Beginning in 2004, the Irish government also began offering a 20 percent tax credit for company spending on research and development, offering high-tech firms an opportunity to cut their taxes by starting up and expanding operations in Ireland. Almost immediately, Ireland became a magnet for new investment and for successful companies that didn’t want to hand over one-third or more of their profits to the tax collector.
The combination of lower corporate tax rates and tax breaks on research and development induced hundreds of multinational corporations to begin operations in Ireland. They brought with them hundreds of thousands of new jobs (and this to a nation of only 4 million residents), and Ireland quickly became number one among the EU’s fifteen original members in being home to companies that conduct research and development. And as for the people of Ireland, their per capita incomes went from the bottom ranks of the EU to the top.
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