Sustained losses in the U.S. auto industry have raised questions in recent weeks about the likelihood of a government bailout. The auto industry's failure to keep up with competition and adjust to new market demands is worsened by a tax structure that discourages production. In order to revive the floundering auto industry, the corporate tax structure should be lowered to a competitive level rather than pouring government money into an anemic industry.

Senior Fellow  Kevin A. Hassett

Suppose you worked hard, invented a better mousetrap and your product was so successful that you registered sales of $171 billion over the past 12 months. How much would your company be worth?

Surely, you might feel like you'd made it to easy street. After all, General Electric Co. had revenue of $180 billion over the past 12 months, and the total market value of the firm was a whopping $295 billion as of Aug. 8. Or maybe you could even do better than that. Cisco Systems Inc. had revenue of $39.5 billion and it was worth $143 billion as of last week.

But before you make your guess, let's add this condition: Your product is an automobile. In terms of market value, that condition is about as negative as it can get. It's like finding out your running back has blown out both his knees.

General Motors Corp. posted $171 billion in revenue over the past year--and its market capitalization as of Aug. 8 was a woeful $5.7 billion. Similarly, Ford Motor Co. posted revenue of $163 billion over the same period and had a market capitalization of just $11 billion. To put this in perspective, General Motors is now worth a little more than half as much as motorcycle manufacturer Harley-Davidson Inc.

The fact is, while automakers have enormous sales, they have losses rather than profits. The companies are worth so little because investors want to own profitable businesses.

Lately, the losses have been frightful. General Motors posted a $15.5 billion loss last quarter and is hemorrhaging money at the rate of about a billion dollars a month. The automaker has about $20 billion on hand, and some have begun to question whether it will survive.

Another Bailout?

Washington insiders are even dusting off their auto-bailout playbooks.

Before legislative action gets going, however, the government needs to consider the sad economics of auto manufacturing. The rationale for any bailout is that short-term fluctuations have put a company in a situation that it doesn't have the liquidity to escape from, but that the long-run prospects are rosy enough that it shouldn't close down.

The popular version of the auto story seems to fit this description. The surge in oil prices has hammered U.S. companies that disproportionately bet their profits on sport-utility vehicles and trucks. Losses are high now, but profits from SUVs were significant in the past. As consumers shift toward more fuel-efficient cars, automakers will suffer while they adjust production but eventually will be profitable again.

This version of the story is inconsistent with the facts. Even in the glory years of SUV profits, U.S. automakers didn't make much money, if at all. The firms have strained to survive, yet have little to show investors they can provide reasonable returns in the long run.

Negative Tax Bill

During the past five years, Ford's tax bill was on average negative, meaning its losses were so large that the company was refunded taxes paid in previous years.

The U.S. companies have a hard time being profitable for a number of reasons. The U.S. product has generally been viewed by consumers as less desirable. Ford and Chevy products have regularly received lower-quality scores from J.D. Power and Associates than Honda Motor Co. and Toyota Motor Corp. And their less-desirable product is manufactured by an extremely costly unionized workforce.

To make matters worse, the main competitors that aren't Japanese all operate out of countries with much lower tax rates than the U.S. When profits do pile up in the good years, U.S. companies pay about 34 percent more in taxes than those operating elsewhere in the Organization for Economic Cooperation and Development, a group of the richest nations. That drains cash reserves that are necessary for retooling when the bad times hit.

Golden Opportunity

U.S. vehicles have suffered from lower quality for a number of reasons that involve both the failure of management and labor. But the bottom line is that any company that has a more costly product that offers lower quality than the competition will have trouble making a profit. A manufacturer can price the profit out of its product in the short run to stay afloat, but long-run prosperity isn't an achievable objective absent fundamental change.

With combined sales over the past 12 months of about $330 billion, Ford and General Motors would provide an enterprising management with a golden opportunity to create a profitable business with a market capitalization that is closer to GE's.

Just Not Profitable

But doing so would require both a radical improvement in product quality and a sharp rationalization of the production process. That's the kind of charge that an eager acquirer might be willing to take on, especially if the U.S. had a corporate tax that made production here more desirable.

If the U.S. stays a high-tax environment, however, then it may well be that investors decide that it's just not profitable to base an auto manufacturer in the country. Only a government-supported industry would be sustainable.

Accordingly, it seems that two distinct paths await the auto industry: Down one, the U.S. has a lower corporate-tax rate, and a large and successful auto industry. Down the other, the government pours money into a failing industry that gets worse and worse every year.

Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.