Why Give Tax Cuts to Manufacturers Instead of Helping the Overall Economy?

Does it make sense for the government to subsidize an industry with declining employment to any further extent than subsidizing a growing industry?  As an investor, which would produce greater return?

In the recent State of the Union address, President Obama highlighted his America Built to Last Plan – a blueprint for boosting domestic manufacturing.  The proposal called for giving a 20% income tax credit to manufacturers that bring their operations back to the U.S., a doubling of tax deductions for advanced manufacturing, and reauthorizing the expensing of businesses investment, along with other recommendations.  Citing jobs as the number one issue for the nation, his proposal is a “long term strategy” intended to bring jobs back into America.

Challenges Remain

While the concept of boosting manufacturing, on the surface, makes sense, it comes with many challenges.  First, as the chart below shows, except for World War II, manufacturing as a percent of total US employment has been on a steady and sharp decline.  This trend comes despite a low dollar that makes U.S. goods cheaper in overseas markets, and such trends are not easily reversed by a one-time tax stimulus.  However, it can be argued that lowering corporate tax rates in line with other countries can provide some competitive parity.  But, why just reduce corporate tax rates on manufacturing?

Manufacturing Chart

The problem with a single focus on manufacturing is that all industries are so intertwined that helping some sectors at the disadvantage of others can be somewhat counterproductive.  For instance, ending tax credits on some energy producers could have the unfortunate consequence of raising energy prices, which in turn could affect manufacturing costs.  For example, the energy cost to produce a single vehicle (including steel, glass, plastic and electronics) could total $2,000 across all of the stages of production – from raw materials to final assembly.  Along with energy, transportation is certainly part of the calculus of where manufacturers will locate, as are many, many other industries.  In fact, manufacturing and information technologies are so inextricable linked that the health of one depends largely on the other, as I will explain.  So, why lower tax rates for one industry (manufacturing) at the cost of all others?

Information Services Link to Manufacturing

Information services, consisting primarily of broadband, video and telecommunications networks, are a major linchpin to the success of domestic manufacturers – both as buyers and suppliers.  As a buyer, manufacturers see broadband networks as a necessary input to its production produce, a means to sell digital goods and software, and the linkage to communications, engineering and design.  Encouraging state-of-the-art broadband and wireless network provides manufacturers with a competitive advantage at home.  Just as industries had located near major transportation centers many generations ago, information transport is a necessary part in design, production, inventory control, distribution and sales.  As such, encouraging investments in information networks, say via tax breaks, is critical to the success of many industries, including advanced manufacturing.

As a seller, manufacturers produce the plant and equipment purchased and installed by network providers.  Just last year, the top ten cable and telecommunications accounted for nearly $50 billion in investment, and, in less than 30 years since the production of the first cell phone, wireless network companies have invested one-third of a trillion dollars in the US economy.  For every dollar invested more than two dollars of production cascades through the economy.  This means that information service providers are major buyers of manufactured goods, which makes this investment vital to spurring economic growth in the economy.  The expensing of plant and equipment purchased by these network companies will encourage more investment in state-of-the-art infrastructure, which would benefit many industries and provide another reason for manufacturers to relocate to the US.  Furthermore, providing additional tax advantages to these network services companies for the purchase of domestic plant and equipment would be doubly beneficial.

There is yet another important link between network service companies and manufactures.  As these investments are made, consumer products are designed and manufactured to ride on these networks.  Specifically, broadband and wireless services have created a market for manufactured consumer goods – smart phones, tablets, notebooks, laptops, desktops, monitors, software, routers and other equipment.  That in turn has encouraged development of web services like Google, eBay, Facebook, Amazon and millions of online and wireless applications.  Furthermore, fiber deployment and upgrades in wireless telecommunications and cable/video networks provide consumer services spark the consumer purchase of cell phones, teleconferencing equipment, set top boxes, digital cameras, HDTVs, game consoles (like Xbox), and so on.  Along with these computing and Internet-enabled devices is the derived demand for software and applications.  In effect, these network services are the path on which consumers ride using electronic consumer goods purchased and hopefully manufactured domestically.  It would be counterproductive to disadvantage network service companies or other information technologies for the benefit of manufacturers, much like it would be counterproductive to help one foot to run faster than the other.

The reality is that information technology service – like transportation, like energy and many other industries – go hand-in-hand with manufacturing and research & development.  There is no need to favor one over the other.

Is it better for the government not to pick winners and losers?

While it would be nice to see resurgence in manufacturing, focusing on manufacturing at the expense of other industries does not mean that more jobs will be created.  The fact is that stimulating one sector of the economy, while disadvantaging other sectors ignores the symbiotic relationship across many industries and that will likely lead to suboptimal results.  A better approach would be to broaden the plan’s focus and take advantage of these linkages.  That should mean broad and permanent corporate tax reforms across all industries, as well as a serious look at addressing the root causes of international competitiveness, if reversal of the manufacturing trend is important a long term strategy.  Picking industry winners and losers will not work to create lasting jobs.

Steve Pociask is president of the American Consumer Institute, a nonprofit educational and research institute.  For more information, visit www.theamericanconsumer.org.

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