Common sense says businesses, driven by profits, will go where they can make the most by paying the least.

Three researchers, Dr Holger Görg from GEP (the Globalisation and Economic Policy Centre, University of Nottingham ) and Professor Hassan Molana and Dr Catia Montagna from the University of Dundee, disagree.

After analyzing data from 18 countries over a 14 year period, the team found that the countries which attracted the highest levels of foreign investment were the ones with higher taxes and higher public social expenditure as a proportion of GDP.

Dr Görg, Associate Professor and Reader in Economics at GEP, said:

"The results may be startling and appear to be counterintuitive.

"Most economists have always argued that globalisation leads to a ‘race-to-the-bottom’ as countries compete to cut tax rates in the hope of attracting multinational investment and the jobs that come with it. The traditional theory is that this then leads to a shrinking of tax revenues and undermines the welfare state.

"But our evidence shows that overall effective corporate tax burdens do not appear to have fallen in response to capital and trade liberalisation, that countries aren’t competing to cut taxes and actually, when investing abroad, firms find countries with higher taxes attractive because they associate them with a happy, stable workforce."

Basically, they are saying there is more than taxation involved in a successful business location. A higher quality workforce and better infrastructure and support are also factors. Granted, but those don't have anything to do with taxes either. The Cato Institute cites Congressional Budget Office estimates that between 20-60% of each tax dollar is wasted in bureaucracy, which is adding no value to the workforce. If anything, lower taxes and less waste would mean more money to compete for quality workers.

There are two considerations this study doesn't explore fully:

1) The companies don't pay taxes if they can shift profits to low-tax areas, so high tax rates are unimportant to multi-national companies, but still crushing to individuals and unsubsidized businesses.

2) Subsidies in return for high taxes are corporate underwriting, not the free hand of the open market. If New York State or Saxony offers $1 billion in subsidies to AMD and declare it an endorsement of their high-tax locations, it's a little deceptive.

The research concedes point one and doesn't factor in point two. The study cites transfer pricing or intra-firm debt contracting as ways that companies lower taxes. In other words, companies ignore high taxes by simply not paying them.

But it's difficult to write a study claiming that high tax rates don't matter and then factor out actual taxes paid as part of the supporting proof.

I mentioned AMD above and the efforts by Dresden and New York to incentivize a new wafer fab with subsidies as examples of corporate underwriting that would allow a company to ignore high taxes. Germany did this same thing for AMD in 2003. AMD's Fab36 cost about $2.4 billion in total. AMD got $500 million as subsidies, $700 million as a "loan" and $300 million as an investment from 2 partners - the German state of Saxony and some European investors. The remaining $900 million came from AMD itself.

Employment: 1,000 people. Yes, 1,000 jobs got $1.5 billion for AMD in Saxony - $1.5 million per employee(!). Four years later they are doing it again.

Given these economics, does anyone really want to emulate Germany? The EU is concerned that globalization will force them to cut taxes so a study like this will have a welcome audience among politicians and businesses that get 60% of their costs underwritten by the working populace - but there's a reason the claim that high taxes attract foreign investment defies common sense:

When you only count businesses that pay no taxes, you aren't really making a scientific comparison.

Source: "Foreign Direct Investment, Tax Competition and Social Expenditure", by Görg, Molana and Montagna.