The Competitive Edge -- Taxes Take Center Stage

Aug. 12, 2010
An analysis of two proposed tax plans shows only one will stimulate the economy and provide important benefits to manufacturers.

In recent months, bond markets, newspaper pundits, government leaders and other opinion makers have coalesced around the seemingly obvious insight that we need to start paying down the mammoth debt that governments in the developed world -- led by the United States -- have been accumulating. Aided by the ideological predilections of the current political leadership in the United States, and the fact that the Bush-era tax cuts are scheduled to disappear on Jan. 1, 2011, this has concentrated minds on tax increases to address the looming fiscal crisis.

Unfortunately, both corporate and pass-through filers in manufacturing are in the sights of the political leadership that sees taxing "the guy behind the tree" -- i.e., business -- as the solution to domestic fiscal problems.

My colleague at the Manufacturers Alliance/MAPI, Jeremy Leonard, has taken a look at the impact of President Obama's proposed tax increases on manufacturing, and it isn't a pretty picture! First, most political leaders and commentators blithely ignore the fact that allowing the Bush tax cuts for "the rich" to lapse will affect many of the four million subchapter S corporations and three million partnerships or limited liability corporations that are at the heart of American entrepreneurial dynamism, including more than 300,000 that are in manufacturing. These filers are hit not only by increases in income tax rates, but by reducing some of the important preference items such as the manufacturing deduction, deferral on foreign-earned income and last-in, first-out (LIFO) treatment of inventory that the Obama plan wants to eliminate or significantly reduce. All told, pass-through entities in manufacturing would see their tax bill increase by 14% under the Obama plan.

C corporations are hurt mainly by elimination of the same preference items, especially the foreign income deferral and LIFO changes. Altogether, these provisions raise corporate taxes by 6% and, importantly, do nothing to change the uncompetitively high top rate that, if proposed Japanese rate cuts materialize, will make U.S. corporations the most heavily taxed in the developed world.

Leonard's analysis also shows that the administration proposals have a negative impact on overall economic activity, cutting about $200 billion from GDP by 2015, cutting jobs by 500,000 and increasing the federal deficit by about $100 billion annually by 2015.

By contrast, another proposed tax reform bill by Sen. Ron Wyden, D-Ore., and Sen. Judd Gregg, R-N.H., would have a positive macroeconomic impact by cutting corporate tax rates and holding individual tax rates at current (Bush-era) levels. Their bill, too, eliminates many preferences that help manufacturers, but the power of lower rates is seen by Leonard's projections. Wyden-Gregg would increase GDP by $500 billion annually and create two million jobs by 2015, and reduce the federal deficit by $100 billion on an annual basis.

Our risk-averse Congress is not likely to address taxes until after the November election, in a "lame duck" session whose actions are unpredictable. Business must be prepared for some tax increase, given the unsustainable fiscal situation we face. Manufacturers will need to weigh the trade-offs between lower corporate and personal income taxes and losses of some preference items. At some point, too, discussion will have to include some form of consumption tax that could be used to offset the impact of lowering the corporate tax needed to stay globally competitive, and to keep personal income taxes and taxes on investment at current levels, which is needed to spur investment and entrepreneurial risk-taking. A consumption tax of some sort also could help reduce the trade deficit by discouraging domestic spending and encouraging investment and exports. Leonard's study shows the power of lower taxes to spur growth, but there will need to be compromises to generate the income required to pay for the profligacy of recent decades.

Thomas J. Duesterberg is president and CEO of the Manufacturers Alliance/MAPI Inc., an executive education and business research organization in Arlington, Va.

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