Question

Give an example of a market distortion and explain what it does to the market.

Answer 1

Answer:

Market distortions are changes in behavior on the part of businesses, households, or individuals for the purpose of reducing their taxes, increasing their subsidies, or avoiding extra regulatory burdens. When a government decides to tax or subsidize a company, group of individuals, or a segment of the economy, it “distorts” the economic outcomes that would otherwise occur in a market free from such intervention because the affected humans simply change their behaviors to capture the subsidies or avoid the higher taxes or extra work.

An example of market distortion is tax inversion. A tax inversion takes place when a corporation merges with an overseas company in a country with a lower corporate tax rate, and then relocates the corporation’s headquarters to the lower-tax nation, usually while retaining its material operations in its higher-tax country of origin. Public opinion has put tremendous pressure on U.S. policy makers to ensure wealthy U.S. companies pay their “fair share” of taxes. This has resulted in America having one of the world’s highest corporate tax rates. To avoid paying such high corporate rates, companies have begun to “invert.” One such high-profile case is Burger King, who recently bought the Canadian coffee and doughnut chain, Tim Hortons, and is planning on moving its headquarters to Canada. Analysts predict Burger King will save hundreds of millions of dollars by inverting. While the purpose of the high corporate tax rates was to ensure American companies paid their fair share, what has actually happened is some companies have found a way to pay no U.S. taxes at all. Some economists argue that a better way to increase corporate tax collections is to reduce the U.S. corporate tax rate to a level it encourages U.S. corporations to keep their headquarters in the United States.

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