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Manufacturing Repairs
The Washington Times
October 2, 2003
By Ernest S. Christian
The continuing drastic decline in manufacturing employment
has finally set off alarm bells, but such troubles should
come as no surprise. Manufacturing has long been on the downhill
slide - fewer manufacturers and fewer employees.
Compared to 1950, manufacturing's share of GDP had been cut
in half by 2000. Since 2000, manufacturing has been disappearing
at the frightening rate of 5 percent yearly, when expressed
as a share of GDP. Since 2001, manufacturing jobs have been
disappearing at the rate of 2 million per year. Job losses
may continue, despite growing prosperity in the overall economy.
So uncertain is the outlook many are now, for the first time,
asking, "What's wrong?"
Heretofore, except for a few complainers dismissed as "protectionists,"
the declining role of manufacturing in America has not been
seen as a matter of great concern. Typically, it has termed
the natural and ultimately beneficial result of free-market
forces.
Because America has a mature, high-wage economy, it is said
to be to our advantage for other, less advanced countries
to do much of our manufacturing for us while we concentrate
our own, generally more cerebral, efforts on something of
higher value (probably having to do with science and technology).
The process of "out-sourcing" manufacturing is said
to be particularly advantageous when foreign factories are
owned by U.S. capital and use U.S. technology.
But, what if the impending demise of manufacturing in America
is not altogether due to natural causes? What if manufacturing's
troubles are heavily influenced by malfeasance on the part
of government - our own as well as others?
We know currency manipulations have artificially cheapened
the price of foreign-made goods relative to American-made.
(The Chinese, for example, compound their cheap-labor advantage
by depressing the yuan.)
We also know our own tax code has long double-taxed manufacturers
- by not allowing them to expense plant and equipment and
by taxing dividends. Some partial relief was recently provided
by the Bush tax cuts, but, even with full relief, the damage
already done is so great it might be many years before manufacturing
in America fully recovers from the misguided tax policies
of the past. Some lost markets may never be regained.
On a global scale, there is another element of double taxation
no one talks about. It occurs through "tax shifting"
- the process by which our trading partners, roughly in proportion
to U.S. imports plus exports, shift a large part of their
home-country VAT taxes onto the backs of U.S. manufacturers.
All this is perfectly legal under treaties to which the United
States is a party - even though the annual amount of foreign
tax shifted to U.S. manufacturers may be so large it equals
or exceeds the entire amount of federal income tax our own
government imposes on manufacturers.
Consider the case of a U.S. manufacturer who exports American-made
products to foreign markets. First, the U.S. manufacturer
pays U.S. income tax on its profit. Then, it confronts foreign
countries' VAT import taxes that typically are about 16 percent
of the gross sales price of the exported product.
The U.S. company has two choices: It can absorb the foreign
tax by reducing its pretax price enough that the total "plus
tax" price to the foreign customer is not increased.
Or the company can allow the tax to increase the price of
its product. If the U.S. company absorbs the foreign tax,
it will maintain sales volume, but its profits will be less
by the amount of the tax. If the company allows the foreign
tax to increase the price foreign customers must pay for its
product, it will have lower sales. Either way, the economic
burden of foreign tax is "backward shifted" to the
U.S. exporter.
Consider further the plight of a U.S. company that sells only
in the U.S. market. In addition to U.S. income tax, it bears
the economic burden of a foreign VAT when it must compete
in the U.S. market with foreign manufacturers who are subsidized
in their own country by VAT rebates on exports to the U.S.
In effect, the foreign-country VAT is "forward shifted"
to a U.S. company that, in order to compete, must reduce its
price by the amount of the foreign tax from which the foreign
manufacturer is exempted on exports to the U.S. For example,
if on Day One the price of widgets is $100 in both Cleveland
and Paris, and if on Day Two the French widget company gets
a $15 tax subsidy for each widget exported to Cleveland, the
great likelihood is that on Day Three the selling price of
American-made (and French-made) widgets in Cleveland will
be much closer to $85 than to $100.
When trade is among countries that adjust at the border for
imports and exports, tax shifting nets out and has no real
effect: Each one's export exclusion offsets the other's import
tax and vice versa.
The problem for the U.S. is, of course, that we alone among
all major nations are outside the loop. To neutralize the
double-tax effect of foreign VATS, we could append to our
corporate income tax import and export adjustments comparable
to those the Europeans and others have attached to their VATs.
But according to a "Catch-22" provision in the current
GATT treaty, we are not permitted to do under our kind of
tax system what the Europeans and others freely do under theirs.
According to them, in order to achieve parity, we must abandon
our kind of tax system and adopt theirs. But the chances of
the U.S. adopting a regular European-style VAT are slim; it
has far too much the appearance of a national sales tax to
ever fit comfortably on this side of the Atlantic. The better
solution is to remove the offending provision from the treaty.
It should never have been acceded to by the U.S. in the first
place.
If we are not able to neutralize tax shifting with border
adjustments of our own, the other solution is to offset the
foreign-origin tax burden - it is probably about $60 billion
per year - by reducing U.S. taxes on manufacturers. Full first-year
expensing should be the first choice. But other business tax
policies, including differentially lower tax rates for manufacturers
and, yes, even the existence of the corporate income tax itself,
also need to be looked at in a new way that takes into account
the total tax burden (U.S. and foreign combined) borne by
manufacturers and, therefore, their employees.
The transcendent issue is American jobs. High corporate tax
burdens were long thought to harm only shareholders, not employees.
That was because many years ago the distinguished economist
Arnold Harberger had concluded in the circumstances of the
time that the U.S. corporate income tax was borne entirely
by capital.
But Professor Harberger has now re-analyzed the problem in
modern circumstances and concluded that, in today's open economy,
the U.S. corporate income tax is now borne almost entirely
by American labor. Professor Harberger reasons that in today's
open economy, overtaxed capital can and will move, and that
there are people all around the world anxious to fill the
jobs capital brings with it.
Let's fix our tax code so we export American-made products,
not jobs.
Ernest S. Christian is a former Treasury tax official who
now does policy analysis for the Center For Strategic Tax
Reform.
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