Santorum and Obama, allies on industrial policy

White House/Pete Souza

President Barack Obama talks with Members of Congress at the U.S. Capitol in Washington, D.C., before delivering the State of the Union address, Jan. 24, 2012.

Article Highlights

  • #Obama, #Santorum see eye to eye on notion that tax system should favor manufacturing over other sectors of the economy

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  • Trying to separate consumer purchases into goods & services is as economically senseless as it is complex

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  • Rather than struggle to recapture the past, we should embrace the economy of the future

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President Barack Obama and Republican presidential contender Rick Santorum have finally managed to find something they agree on. Despite their many differences, they see eye to eye on the notion that the tax system should favor manufacturing over other sectors of the economy.

"Obama, Santorum, Congress and the IRS aren’t equipped to decide what combination of goods and services best meets the needs of American consumers." -- Alan Viard

In his new corporate-tax-reform framework, President Obama calls for focusing the existing tax break on domestic production more tightly on manufacturing, with bigger tax savings for “advanced” manufacturing. The Santorum tax plan goes even further, advocating the complete elimination of corporate income taxes on manufacturing. Unfortunately, these proposals fly in the face of sound economic policy.

For one thing, manufacturing tax breaks are more complex than you might think. You have to figure out what manufacturing is before you can single it out for tax savings. The domestic production tax break, which Congress said should go to the making of goods -- but not to the provision of services -- has struggled with such definitions for the past seven years.

Coffee Test

For example, in the regulations carrying out this tax break, the Internal Revenue Service has declared that brewing coffee at a retail shop is a service while roasting coffee beans away from the shop is part of a sale of goods.

Trying to separate consumer purchases into goods and services is as economically senseless as it is complex. After all, consumers cannot live by goods alone. Is medical care that saves lives and relieves pain any less valuable because it’s a service rather than a good?

Obama, Santorum, Congress and the IRS aren’t equipped to decide what combination of goods and services best meets the needs of American consumers. Only consumers are able to make those decisions, which they do every day in the marketplace. Two centuries of economic analysis establish that the free market normally directs economic resources to their best use. Unfortunately, targeted tax breaks like those proposed by Obama and Santorum tilt the playing field and short-circuit the workings of the market.

Much of the infatuation with manufacturing reflects economic nostalgia. Manufacturing now accounts for less than 10 percent of total U.S. employment, down from almost 30 percent six decades ago. It may seem tempting to try to undo this shift and return to the real or imagined glories of the past. But any such effort runs headlong into the powerful forces that have shaped our economic history.

International trade has played some role, as American consumers have found that they can buy some manufactured goods more cheaply from foreign producers. But, the impact of trade is a sideshow compared with the economic effects of the manufacturing sector’s phenomenal productivity growth.

Fewer Workers Needed

With today’s technology, far fewer workers than before are needed to produce the same bundle of manufactured goods. This productivity growth holds down employment in this sector. Meanwhile, the need for fewer workers makes goods cheaper. With less of their budget soaked up by purchases of goods, consumers are liberated to buy more services. Employment rises in the services sector as it shrinks in the manufacturing sector.

This is not the first time that productivity trends have fueled a dramatic transformation of the U.S. economy. Rapid productivity growth in farming led to a relentless dwindling of the fraction of Americans employed in agriculture. But nobody suggests that the government try to turn the clock back to the 19th century by inducing tens of millions of workers to return to the nation’s farms. It makes no more sense for the government to try to defy market forces by keeping workers in the nation’s factories.

Rather than struggle to recapture the past, we should embrace the economy of the future. Manufacturing will undoubtedly play a significant role in that economy. But its role should be set by consumers’ market decisions, not artificially bolstered by government subsidies and special tax breaks.

Alan Viard is a resident scholar at AEI.

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About the Author

 

Alan D.
Viard
  • Alan D. Viard is a resident scholar at the American Enterprise Institute (AEI), where he studies federal tax and budget policy.

    Prior to joining AEI, Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also been a visiting scholar at the US Department of the Treasury's Office of Tax Analysis, a senior economist at the White House's Council of Economic Advisers, and a staff economist at the Joint Committee on Taxation of the US Congress. While at AEI, Viard has also taught public finance at Georgetown University’s Public Policy Institute. Earlier in his career, Viard spent time in Japan as a visiting scholar at Osaka University’s Institute of Social and Economic Research.

    A prolific writer, Viard is a frequent contributor to AEI’s “On the Margin” column in Tax Notes and was nominated for Tax Notes’s 2009 Tax Person of the Year. He has also testified before Congress, and his work has been featured in a wide range of publications, including Room for Debate in The New York Times, TheAtlantic.com, Bloomberg, NPR’s Planet Money, and The Hill. Viard is the coauthor of “Progressive Consumption Taxation: The X Tax Revisited” (2012) and “The Real Tax Burden: Beyond Dollars and Cents” (2011), and the editor of “Tax Policy Lessons from the 2000s” (2009).

    Viard received his Ph.D. in economics from Harvard University and a B.A. in economics from Yale University. He also completed the first year of the J.D. program at the University of Chicago Law School, where he qualified for law review and was awarded the Joseph Henry Beale prize for legal research and writing.
  • Phone: 202-419-5202
    Email: aviard@aei.org
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    Name: Regan Kuchan
    Phone: 202-862-5903
    Email: regan.kuchan@aei.org

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