You can’t engineer around tax rates

The theme of this year’s Technology Day at MIT was advanced manufacturing in the U.S. Kresge Auditorium was close to capacity with alumni from all reunion years (I’m celebrating my 100th!). Marcie Black, founder of Bandgap Engineering, and Nathan Ball, founder of Atlas Devices, gave inspiring talks about advanced solar cells and an innovative climbing machine. Learned MIT faculty weighed in on the importance of proximity between engineers and factories. The Atlas Device story was initially an inspiring tale of can-do New England spirit, with engineers in Somerville and a machine shop in Woburn working together to make improvements on a weekly basis. But then we found out that the main customer was the U.S. military and they really didn’t care how much it cost or how efficiently it was produced. Similarly, the solar cell talk was great until we learned that there are about 12 good reasons why solar cells must be manufactured in Asia.

In a panel discussion afterwards, the speakers were asked what it would take to make the U.S. more competitive for manufacturing. The answer was that it was pretty much hopeless at current tax rates. Big companies make a lot of money in foreign countries, but if they bring the profits back home they get hit with the world’s highest corporate tax rate. So they leave the money in China, for example, and then invest it there in research and development or a new factory. I.e., our own multinational companies are financing the new facilities around the world that are rendering the U.S. uncompetitive. A new enterprise, meanwhile, would be facing a choice between China, with a 15 percent corporate tax rate, proximity to all kinds of suppliers, and low costs, and the U.S., with a 35 percent tax rate (plus any state corporate income tax) and an ocean separating it from most component vendors.

Other than for defense contracting, nobody seemed optimistic about the U.S. becoming comparatively more attractive. (Can we still call it “defense” when we keep starting the wars?)

[I was a bit skeptical of the message that high costs and taxes explain the U.S. decline. After all, Germany has high costs for everything and Europeans are famous for high tax rates. Yet Germany is wonderfully successful in manufacturing. Then I looked up the corporate tax rate in Germany and it turns out to be 15%, the same as China’s.]

25 thoughts on “You can’t engineer around tax rates

  1. Phil,
    It’s not so simple. KPMG’s 2011 survey of world tax rates [1] says that the corporate tax rate in Germany is 29.37%. The US rate is 40%. It also lists China’s corporate tax rate as 25%. (It’s interesting to note that, though there are footnotes on most countries’ corporate tax rates, there is no footnote on China).
    Another sign that German corporate tax rates are not so low is the dispute inside the EU over Ireland’s ultra-low rate (12.5% according to KPMG). If Germany’s rate were really 15%, the Irish rate would not be such an acrimonious issue within the EU.

    [1] http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/corporate-and-indirect-tax-rate-survey-2011.pdf

  2. You cannpt tax your way to prosperity, which is what the American government insists on doing. The current policies of tax and spend punishes businesses. As long as that keeps happening, as long as the rates are higher than elsewhere, businesses will have no choice but to expand elsewhere.

    If you want less of something, tax it more.

    It’s so simple, that only an ivory tower academic could fail to understand it.

  3. Germany’s top 5 markets for export are France, US, Netherlands, UK, and Italy. In other words, Germany exports mainly to its neighbors, which are also high cost, high tax, wealthy countries. Vehicles and machinery comprise a large part of Germany’s exports.

    http://en.wikipedia.org/wiki/File:2006German_exports.PNG

    Taxes notwithstanding, it would be hard for the US to replicate Germany’s success in manufactured goods because (except for Canada) our neighbors aren’t so rich.

    What’s more, contrary to inaccurate reports in the financial media, the US is still the world’s largest manufacturer.

    http://www.shopfloor.org/2011/03/u-s-manufacturing-remains-worlds-largest/18756

    Though I agree with your point about corporate taxation (and I think the US corporate tax rate should be zero), the US certainly is doing some things right in manufacturing. Having labor intensive, low productivity manufacturing done in low wage countries may be a good idea from an economic point of view (see “comparative advantage”).

  4. Where are you getting these rates from? WHat you really need to look for if the effective rate. Ask the question, which has been asked here before; How much did GE pay in taxes last year?

    Basically even if the rate is XX%, GE’s lawyers are better than government tax bureaucrats and the legistatures that write the laws so GE gets away with it. WHo gets hurt is the little guy as usual.

    If the US was truly that bad why are 98% of Toyotas sold here made here?

    The source may be biased but consider these 2 articles:

    http://thinkprogress.org/economy/2012/02/27/432749/buffett-corporate-tax-myth/

    http://thinkprogress.org/economy/2012/03/30/456005/reminder-corporate-taxes-very-low/?mobile=nc

  5. The world’s 15 largest economies (including China and Brazil) have an effective corporate tax rate of 25.3 percent, while we have one of 27.1 percent. If you do the average and weigh for GDP, we’re actually below average. Same result if you compare us to OECD countries.

    See Table 2 and Table 1 in this Congressional Research report PDF http://assets.opencrs.com/rpts/R41743_20110331.pdf

    The thing is, we have a high official rate (0-40%) with tons of loopholes, while China has a lower official rate (25%) with lots of hidden costs (bribes, kickbacks, insufficient legal system and regulation of other businesses ripping you off). Presumably these manufacturers are not sufficiently satisfied with the loopholes for capital expenditures, interest (they probably can’t borrow, since Obama lavished money on the banks without forcing them to lend more), health care costs (100% deductible if you’re a business) and other manufacturing specific costs, and want a more targeted loophole.

    http://www.nytimes.com/2011/05/03/business/economy/03rates.html

  6. Corporations never pay any tax. Their customers do. All taxes do is distort the costs of manufactured goods and of the wages to make those goods, and ultimately make it impossible to produce some goods that people would like to have. They also encourage corporations…which have deep financial pockets…to corrupt politicians through campaign contributions and other ‘favors’ in order to get favors in return. This further distorts the winners and losers in the market place.

    We need to burn the current tax code: Federal, state, and local. We need to put in place a tax system which is simple, consistent across all levels of government, and limited by law. It should be unlawful for government to create new forms of taxation (under any name) and to raise taxes beyond a certain percentage of per capita GDP. We have to eliminate the lie that revenue can be increased by increasing taxes. Any increase in the government’s ability to spend must be caused by increases in real GDP and real standards of living. If politicians want to spend more, they must be forced to use their power to expand our economy, and not to leech off it. And government must be made to live within its means.

    It should also be unlawful for government to use taxation to encourage or discourage specific behaviors and products.

    Whatever the single new tax mechanism should be, it should target taxes at one point and one point only. I want GE employees, shareholders, officers, etc. to “pay their fair share” according to the wealth they receive from GE. But it is pointless to tax the fictional entity “GE” when all that does is distort the market and encourage GE officers to distort our political process.

  7. Beau,

    Your point about the Toyotas being being made here is irrelevant. Most cars sold here are made here, simply because it costs less to manufacture them here than it does to manufacture them cheaper elsewhere and then ship assembled vehicles here. Fully assembled vehicles are hardly efficient things to ship, especially in bulk. It ends up cheaper to make them here.

    On the article, I simply don’t see how the US can be a competitive manufacturer anymore. We are used to such a high standard of living, which is great. But when workers overseas are willing to work for a mere fraction of what a US worker expects for the same work, I don’t see any compelling economic reason to manufacture here. The exception of course being when the cost of shipping the goods outweighs the savings of overseas manufacturing.

  8. This article is nothing but a big excuse. The fact of the matter is that it is riddled with inaccuracies that crack the primary premise into pieces. For some reason Americans, of which I am one, lack the ability to see reality for what it is. For whatever reason, our collective relationship towards taxes has been poisoned through decades of psychological warfare by a wealthy class that has no interest in the USA beyond exploiting it and turning it into as much of a plutarchic system as possible.

    The problem does not lie with tax rates, it lies with justice. We have been conditioned, as a people, to accept that corporations take advantage of all that the USA has provided and offers through its consumer base, and at the same time dump all the externalized expenses and costs on us.

    In a country whose corporate tax rate is not even worth mentioning for all the loopholes and adjustments that allow corporations to pay zero percent effective tax rates; we should start thinking about taxing all foreign profits of American companies that want to take advantage of our markets, society, and corrupt our government. The American tax payer I’d getting a raw deal by the wealthy who could not give two shits about the USA or its average citizen as long as their exploitation continues. It is the spirit of the slave driver that has never been eradicated from our society that drives the same kind of mentality, just in a different form.

    It is a testament to the sham core of our economy that the wealthy are constantly whining about how bad they have it and making excuses for their difficulties. As mentioned, the author is wholly and possibly intentionally deceptively ignorant about Germany’s corporate tax rates. But that doesn’t even matter, Germany does not have a psychotic relationship towards taxes and there is a social element to it that we as an undeservedly entitled feeling people and our corporations don’t get; that if you want things, someone has to pay for them, one way or another.

    I can also tell you, Germany’s manufacturing success has very little to do with tax rates, one way or another. Claiming otherwise is just plaing stupid ignorant.

    That is the problem!

  9. Not sure where you get the 15% tax rate for Germany from. For my German business its over 30%. Hm, not very well researched post…

  10. No, lowering taxes won’t make the other 11 issues go away, because we also need to reduce regulation, and at the risk of being redundant, corruption.

    But it is government abuse of the economy that is the cause of all 12 issues.

  11. Bullshit!

    SpaceX does it with USA tax rates. Maybe you should invite Mr Musk there to explain how? Remember, insurance and retirement benefits were ‘given away’ in early 1900s when those things cost less but once a a benefit is given out it rarely gets adjusted to reality.

    Do you know what the difference between doing inefficient spending on health insurance and retirement benefits and efficient spending is? Its the 1%% difference between our 40% corporate tax rate and China’s/

    That vertical cost efficiency that SpaceX uses can be applied to other US industries and that really is Mr Musk’s gift to the US Manufacturing Industries.

  12. The flat 15% federal tax in Germany is always complemented by the trade tax at the municipal or communal level. This explains most of the difference to the 29.37% percent John talks about.

    I think most large U.S. corporation prefer a 35% tax they can evade than a flat tax rate of 15% they can’t evade (at least not as easily). Without talking about the Trade Tax which is not deductible from profits for corporations.

  13. Fred: SpaceX would not exist without US government funding. As the original post said, if the government is willing to spend money on a company without concern for profit or efficiency, then that company can succeed even if it’s American.

  14. To those who say GE is evading U.S. corporate income tax, Jeff Immelt had a reasonable response:

    “Our technique for paying low [corporate income] taxes in 2009 and 2010 was writing down $32 billion in our financial services business. I wouldn’t recommend it.”

  15. DT:

    Nonsense.

    Whiles taxes do create a dead-weight loss the portion of the tax burden that producers can pass onto consumers depends on the elasticity of demand. If the demand is elastic than the dead-weight loss comes out of the producer’s surplus if demand is inelastic it comes more from the consumer’s surplus.

    Also using tax policy to encourage or discourage activities that have externalities associated with them corrects market distortions. The price of a kilowatt hour of electricity should reflect the cost imposed on third parties by pollution.

  16. I think you also need to consider various tax treaties which prevent double taxation of profits. German companies can usually repatriate profits from foreign operations without being taxed again.

    Even better would be to go as far as countries like Australia where there are arrangements to prevent double taxation of company profits once they are distributed as dividends to shareholders http://en.wikipedia.org/wiki/Dividend_imputation

  17. In this case, the US decline in manufacturing is less of a corporate tax rate vs. “growing up” (read: spoiled.)

    I’m no historian, but if you look back to 1800’s, 1900’s etc. when the US was the king of manufacturing, you will see that during those periods, folks who worked their ass off, with little complaint, did so just like what you see today in China, India and other developing nations: working conditions is no difference.

    We lost out edge when the US “matured” (read: government policies, organized unions, protest, etc.) Once China and India come out of their current “start-up” mode, they too will start to lose the manufacturing edge that they have now.

    In short, today, I won’t let my employee force [1] me to work 12 hours and 6 days a week straight in a harsh condition, even when this is the only job I may have to feed my family. This was not the case 100 or even 50 years ago.

    [1] Even if I agree and accept such conditions, our government and unions won’t let me!

  18. Romney will lower corporate taxes. Do not reobama (edited for political correctness).

  19. Arthur – “Whiles taxes do create a dead-weight loss the portion of the tax burden that producers can pass onto consumers depends on the elasticity of demand. If the demand is elastic than the dead-weight loss comes out of the producer’s surplus if demand is inelastic it comes more from the consumer’s surplus.”

    Which is the reason I typed the second sentence: “All taxes do is distort the costs of manufactured goods and of the wages to make those goods, and ultimately make it impossible to produce some goods that people would like to have.”

    Corporations have no real “surplus.” They are fictional entities. If the taxes aren’t paid by the consumer, they are paid by the workers (lower wages) or the shareholders (lower returns and stock value). At some point they’re not paid at all because the good simply cannot be produced.

    Arthur – “Also using tax policy to encourage or discourage activities that have externalities associated with them corrects market distortions. The price of a kilowatt hour of electricity should reflect the cost imposed on third parties by pollution.”

    Energy demand is highly inelastic, so taxes do little to nothing to correct any externalities of its production. And the taxes collected are not in any way remitted to the people who bear the externalities of pollution.

  20. The corporate tax is not about generating income. If the corporate tax were set to zero, all the money would eventually work its way out of the corporations as taxable personal income. (Dividends, spending on salary, services, equipment from other corporations which then, etc.) The corporate income tax is about control. “Tax incentives” exist to encourage behavior, and without tax, there can be no tax incentives. In general, it’s a disincentive for corporations to attempt to allocate their income in the ways that they feel make the most sense.

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