Bloomberg News

Santorum and Obama, Allies on Industrial Policy: Alan D. Viard

February 22, 2012

Illustration by Dylan C. Lathrop

Illustration by Dylan C. Lathrop

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.

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 D. Viard is a former senior economist at the Federal Reserve of Dallas and a resident scholar at the American Enterprise Institute. The opinions expressed are his own.)

Read more opinion online from Bloomberg View.

To contact the writer of this article: Alan D. Viard at aviard@aei.org.

To contact the editor responsible for this article: Katy Roberts at kroberts29@bloomberg.net.


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