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The Right Reform

Making the case for pro-manufacturing tax reform

Cincinnati Inc. has been making machine tools in southwest Ohio for more than 100 years. It’s one of only a few original equipment manufacturers in the United States, and it’s very good at what it does. And while business is good, says sales manager John Prevish, some things are out of his control.

“Sales of our fabrication equipment have been keeping pace with 2013 results and we are hopeful for a strong finish going into December, despite the lower allowable Section 179 tax expense and unavailable bonus depreciation in 2014,” he wrote in an email.

Prevish is referring to two tax benefits that allowed companies to write off equipment purchases, both of which expired at the end of 2013. While the 113th Congress extended these benefits before it adjourned, it only did so for the 2014 calendar year. And the uncertain future for these incentives makes it hard for Cincinnati Inc. to plan and invest in new capital equipment.

Tax reform on the table
As the 114th Congress convened in January, it did so with a different look and a different power structure. In 2015, Republicans will set the agenda in both chambers, and though their politics might not leave room for much agreement with the Obama administration, one area stands out: Tax reform is on the table.

Section 179, bonus depreciation and the kitchen sink will be on the table, too. For years, American businesses have chafed at the world’s highest corporate tax rate and have steadily called for comprehensive reform. But while both the president and congressional Republicans say tax reform is the rare common cause, actual progress on this issue is hardly a safe bet.

And, if reform actually happens, it’s unclear if the right kind of progress will be made. Even in these early steps toward reform, Washington must recognize how profound an effect the tax code has on the structure of the U.S. economy.

Will its exporters remain globally competitive? Will it retain the ability to generate middle-class jobs? Will Prevish’s job get any easier? Will it be worth investing in new equipment to expand production at Cincinnati Inc.? Pushing the tax code in the wrong direction could have devastating effects. But pushing it in the right direction could spur the manufacturing revival we’ve all been waiting for.

To make the right reforms, both parties must adopt this simple mantra: Tax reform must do no harm to American manufacturing.

Unfortunately, harm is a real possibility. In the name of purity, some economists, Wall Street banks and retailers have called for a simple, tidy elimination of all corporate tax deductions and credits to make way for a corporate rate cut. Funny thing is that Wall Street and retailers face very little global competition, while it’s the name of the game in manufacturing. We must bank here and shop here, but things can be made anywhere in the world.

That sounds like an elegant solution. But if you think it sounds too good to be true, you’d be correct: Its net effect would be to dramatically raise the tax bill for manufacturers like Cincinnati Inc.

The multiplier effect and more
There is plenty of evidence suggesting that manufacturing provides a larger positive role in our economy than other sectors. Manufacturers, for example, offer more middle-income job opportunities for American workers. The multiplier effect from manufacturing activity – the number of additional jobs supported by each job in manufacturing – far exceeds any other type of business. Consider this: Every dollar in America that heads toward the financial sector costs the rest of the American economy 60 cents. With manufacturing, the opposite is true.

What’s more, the relationship between the location of production and innovation is well established; innovation and manufacturing go hand-in-hand. In fact, the manufacturing sector accounts for 90 percent of all new patents and 70 percent of private-sector R&D.

Goods production accounted for the lion’s share of America’s exports last year, so if the United States wants to continue to lead on innovation, keeping more of our stuff American-made is a must.

But none of these benefits come easy. Manufacturers face global pressures in a way that most service providers don’t. Most of America’s foreign economic competitors provide rebates for their exporters through a value-added tax system that may bestow as much as a 17 percent tax benefit, while adding a VAT tax on imports from other countries. Since America’s low tariff rates and foreign investment guarantees have made offshoring increasingly attractive, a reworked tax code should increase the incentives for keeping manufacturing activity stateside, and maintain the ones that already exist.

As Prevish can attest, manufacturing is capital intensive. To operate and grow, his company needs to be able to borrow a lot of money over a long-term horizon. The existing tax code acknowledges that reality via accelerated depreciation and other cost recovery mechanisms, which help ensure that banks are willing to lend to companies like Cincinnati Inc. and its customers. But, because manufacturing activity rises and falls with the business cycle, the tax code should also include mechanisms for allocating losses in a reasonable manner.

But haphazardly lowering the corporate tax rate by eliminating credits and deductions used by American manufacturers would reduce incentives to make things here in America. That’s the wrong approach.

Despite the pitfalls inherent in the tax reform effort, there’s reason for optimism. Plenty of members of Congress from both parties recognize the critical importance of maintaining a balanced economy – one that encourages investments in factories and workers here in America, rather than seeing more of our work shift overseas. They’ve listened to voters across the political spectrum, who have consistently voiced support for the U.S. manufacturing sector.

But advocacy on behalf of pro-manufacturing tax policy should continue until it’s the dominant position in the field. Now that the holidays have wrapped up and we all have a few more moments to spare, I recommend calling your representative and telling them something like this:

At the end of the day, it’s the Cincinnati Inc.’s of America that build our middle class and economically support suppliers throughout the country. Tax reform should be designed to grow manufacturing jobs, not shrink them. That, in turn, will grow our economy.

Alliance for American Manufacturing