Tax Policy Makes U.S. Uncompetitive, Not China’s Low Wages

By Henry R. Nothhaft
February 7, 2011

President Obama delivers his weekly address on Feb. 5, 2011

In his February 5th radio address, President Obama noted that “If we make America the best place to do business, businesses should … set up shop here, and hire our workers, and pay decent wages, and invest in the future of this nation. That’s their obligation.”

I agree. But government has an obligation, too. Is it doing all it can to truly make America the best place to do business?

Consider Evergreen Solar, which until last month was one of America’s largest solar panel makers. On January 14th, it shut down its Massachusetts factory and sent 800 jobs to China. This leaves only Silicon Valley’s Solyndra making solar panels in the U.S., and it just shut down one of its two production facilities.

Why did Evergreen flee to China?

Many people assume that there’s no way American manufacturers can compete with cheap Chinese labor. It’s just basic economics, right? Wrong. It’s the U.S. government’s myopic policy, not China’s lower payroll costs, that make our nation uncompetitive in the all-important solar and other high-tech manufacturing sectors.

According to Massachusetts’ former energy chief, Ian Bowles, the real challenge for Evergreen Solar was not labor costs but the fact that China offers manufacturers, both domestic and foreign, huge tax and other incentives whereas America does not.

“[Our] government has brought a knife to a gun fight,” Bowles told the New York Times on January 14.

And he’s right. The U.S. is the only major nation on earth that does not offer tax breaks, capital grants, low-cost loans or other meaningful incentives to high-tech manufacturers. But could America really compete with Chinese labor even if we did offer incentives?

Absolutely, says Louis Vintro, vice president and general manager of the semiconductor product division at equipment maker ESI: “What we see from our data is that China has a roughly 50 percent advantage in labor costs,” he explained in an interview for my upcoming book, Great Again. “But since labor represents an average of only 7 percent of operating costs across all of the semiconductor sectors, that means China has a 3.5 percent overall cost advantage.” Add in China’s tax holiday and firms locating there get an additional 2.5 percent advantage, if you assume they avoid paying 25 percent tax on a 10 percent operating profit. That brings China’s total cost advantage as a manufacturing location to roughly 6 percent.

But what if manufacturers were given a tax holiday in the United States? If you take as a guide the roughly 30 percent tax that Intel has paid in recent years on 10 percent operating profit, that would mean a 3 percent lower cost of operating a plant here. Add in an enhanced, permanent 20 percent R&D tax credit equal to what other nations offer—and again, America is the only major nation refusing to offer such a credit—and China’s advantage drops to 1 to 2 percent.

We can definitely compete with that.

As Vintro notes, “The U.S. still retains a very high percentage of the R&D centers and the high-tech machinery used in manufacturing. Companies can use the faster time to market they’d get by locating their plants here — and all the other benefits of having their R&D closer to manufacturing — to remain competitive with, if not superior to, anything the Chinese can do in the high-tech field. But we’ve got to have help from Washington.”

Former Intel chairman Craig Barrett once explained it this way in testimony before Congress: “[It] costs $1 billion more to build, equip and operate a factory in the U.S. than it does outside the U.S. The largest portion of this cost difference (about 90 percent) is attributable to taxes [and] capital grants. Labor cost is not a large difference.”

I grew up in the once-thriving middle-class community of Sharon, Pennsylvania, where I watched the steel industry flee offshore, causing the collapse of the whole economic ecosystem built around it. Today I’m starting to see the same hollowing out of the middle class happening in my adopted home of Silicon Valley.

I am the son of a steelworker, and I did not work my whole life creating jobs and wealth just to spend my golden years in some banana republic of Silicon Valley. So let’s ask ourselves why China and Europe go to such great lengths to attract manufacturers. It’s because they know that manufacturing is the greatest economic force multiplier on earth, creating up to 15 additional jobs outside of manufacturing for every position on the shop floor.

It’s time we joined the rest of the world in recognizing that fact. Only when we do will America truly be the best place to do business.

Other recent articles on U.S. innovation and job creation

Harvard Business Review: Memo to the President: Looking for Jobs in All the Wrong Places
Manufacturing  Technology News: Economic State of the Union: The Future Will Likely Be Worse
The Hill.com: Leahy Patent Bill: Litigation, not Innovation
IAM Magazine: A Message You Just Cannot Argue With
The Wall Street Journal: U.S. Firms, China in Tech War

The Author

Henry R. Nothhaft

Henry R. Nothhaft

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 12 Comments comments.

  1. IANAE February 7, 2011 4:21 pm

    labor represents an average of only 7 percent of operating costs across all of the semiconductor sectors,

    If labor represents 7% of operating costs, and the tax difference represents about 3-6% of operating costs, the US might as well pay that tax cut directly to unemployed people. They’ll still create those other 15 jobs per person, because most of those jobs result from paid employees buying stuff they need to survive.

    If they spread the money more thinly across a larger population than the factory would employ, more of it will be spent and less will be saved, resulting in even more economic benefit.

    What’s more, the 1-2% deficit might slow relocation to China, but it won’t bring anybody back, and Mexico is still much closer to US manufacturing. And of course, there’s the option to also outsource your R&D to the same place as your manufacturing, because your US patent is worth exactly the same no matter where you’ve invented the thing. Competing on price doesn’t build any loyalty, especially from corporations, and it will ultimately end the same way for the companies as it did for their unionized workforce, but in the meantime the companies’ entire tax burden will be shouldered by the workers who, let’s face it, are still going to have to compete with Chinese salaries to some extent.

    All this to say that if companies are only spending 7% of their costs on labor, it’s because manufacturing simply doesn’t employ as many people as it used to back in the day when we still had actual packers and steelers. A highly-automated high-tech manufacturing facility is a very inefficient way to turn money into employment.

  2. Gene Quinn February 7, 2011 5:19 pm

    IANAE-

    Wrong once again. Perhaps you have not been noticing, but giving money to people in the form of handouts doesn’t stimulate the economy. We have tried that repeatedly and it just doesn’t work.

    Furthermore, a 1% to 2% deficit, as you call it, would certainly bring back manufacturing from China. Perhaps you should take a look at this article from the Milwaukee Journal Sentinel:

    http://www.jsonline.com/business/112759524.html

    As you can see some manufacturing is already coming back from China for a variety of reasons. As the Chinese middle class starts to demand more freedom, pay and services the unrest will grow, wages will grow and competitive advantage for China will cease. We can meaningfully facilitate that by taking the steps that Hank suggests.

    -Gene

  3. Ron Hilton February 8, 2011 9:53 am

    I have felt for many years that the single best thing the US government could do to fix the trade deficit and bring offshore jobs back home would be to completely abolish the income tax and replace it with a broad-based national consumption tax. In particular, taxing businesses makes no sense at all. The cost just gets passed along to consumers and investors in the form of higher prices and lower returns, and in effect becomes a very regressive “hidden” tax. That hidden tax gets multiplied all the way up through the production chain and puts our exports at a huge disadvantage. By contrast, a consumption tax would apply to imports (as well as domestic goods and services) but not to exports. As a result, it would be a huge magnet attracting US corporations to stay here and foreign corporations to relocate here. But no, Washington in its infinite wisdom is intent on “soaking” the rich, including big bad business and greedy Wall Street. Plus the armies of special interest lobbyists virtually guarantee that the byzantine income tax with its myriad exemptions and special breaks will never be repealed. So we muddle along and whine and plead for this or that business tax credit, when we really need to just deep-six the whole broken system.

  4. IANAE February 8, 2011 9:57 am

    giving money to people in the form of handouts doesn’t stimulate the economy.

    That’s been tried a lot during the recent Republican administration, has it? I suppose it’s very different from giving money to people in the form of loans, which is what the banks are supposed to be doing with their handouts, and what people are supposed to use to turn their IP into jobs.

    Giving money to poor people doesn’t stimulate the recipients to go get jobs and be productive, that’s for sure. It does, however, stimulate consumer spending much more than tax cuts for rich people and companies who already have stacks of idle cash sitting around. How badly do we need domestic productivity in low-skilled jobs that are more economically done overseas and thereby make consumer goods more affordable for those of us who do have money?

    And at what cost do we let China dictate our tax policy?

    Perhaps you should take a look at this article from the Milwaukee Journal Sentinel:

    “Often no more than a single technician oversees multiple banks of automated equipment, capable of shaping parts within one-3,000th of an inch.”

    Three dozen human jobs and several hundred highly-skilled American robot jobs. What a triumph for the American worker.

    Seems like it’s less about labor cost or taxation than it is about a 20% spike in a currency exchange rate that’s particularly hard for the US to influence. And as soon as it’s cheaper to ship those jobs back overseas, you can kiss them goodbye again. That essentially means not taxing companies forever, as long as China can keep it up, and still hoping that all the other factors beyond our control (exchange rates, shipping costs, labor costs) stay tenuously favorable.

    As the Chinese middle class starts to demand more freedom, pay and services the unrest will grow, wages will grow and competitive advantage for China will cease. We can meaningfully facilitate that by taking the steps that Hank suggests.

    I presume we’re doing that whole “international democracy” thing where we support the rights of Chinese workers to unionize while vilifying unions here at every turn. I hope that doesn’t conflict with the policy of not taking too close a look at China’s human rights situation.

  5. Gene Quinn February 8, 2011 12:47 pm

    IANAE-

    Once again you employ your liberal tricks. You make a comment that is objectively and provably wrong and then in your retort you change what you said as if we cannot go back and read what you have said previously. You said nothing about loans to businesses to expand, yet now your argument is based on that. I am really growing tired of your debating tactics and the hijacking of comments.

    That you think it would have been a good idea to raise taxes on the rich and raise taxes on 100% of small businesses is beyond me. I know you will say that wasn’t what was going to happen, but we both know otherwise. Small business owners take a reasonable salary and then profits are taken as a dividend. When the dividend rate would have gone up 100% of small businesses would have had their taxes increase regardless of what the Obama Administration said. So you can talk all you want about raising taxes on the rich, but the truth is you don’t become a prosperous nation by taking more and more from those who are the most productive. History shows us that when you do that those who are energetic and necessary to grow the economy cease to be motivated. Please do some basic research.

    As far as letting China dictate our tax policy, you have to be kidding. Do you let other businesses in your field dictate the way you do business? Of course you do if you want to stay in business. You have to continue to evolve. If you are stagnant and others are nimble and provide better services for less money then your customers go elsewhere. The same is true with corporations in a global marketplace. If it is cheaper to do business elsewhere, if there are research funding opportunities elsewhere that is where the businesses will go and that is where the jobs will go. You myopic view of the world seems to be exactly what Hank is talking about in this article.

    -Gene

  6. Gene Quinn February 8, 2011 12:54 pm

    Ron-

    You say: “we muddle along and whine and plead for this or that business tax credit, when we really need to just deep-six the whole broken system.”

    I personally would agree with that. If we could get to a more fair tax system for personal income and for businesses that would be great. I would prefer to lower tax rates across the board, do away with most deductions and make it harder to cheat with a more simple formula. Of course, that seems unlikely to happen because everyone wants the other person’s breaks to go away but not their own. So in the meantime we are left to play with the ridiculous tax code to attempt to make it as attractive to do business in the US as it is elsewhere. If Obama and Congress can do anything hopefully they will at least set the foundation for a meaningful discussion of tax reform.

    -Gene

  7. Anon February 8, 2011 2:22 pm

    Gene,

    I am really growing tired of your debating tactics and the hijacking of comments.

    That is the staple of IANAE’s debating tactics. Just visit Patently-O to see his handiwork.

  8. Gene Quinn February 8, 2011 2:43 pm

    Anon-

    Thanks for the information. It has been suggested to me that it might be about time to ban IANAE. I’d rather not do that, but the provably false comments and then ridiculous slight of hand as if we cannot read what was said earlier is growing tiresome.

    -Gene

  9. Yet Another Examiner February 8, 2011 6:23 pm

    “Perhaps you have not been noticing, but giving money to people in the form of handouts doesn’t stimulate the economy. We have tried that repeatedly and it just doesn’t work.”

    So you’re all in favor of repealing the Bush tax cuts then?

  10. Gene Quinn February 8, 2011 10:29 pm

    YAE-

    Not at all. The Bush tax cuts are essential, particularly now. One off payments don’t work, but giving people more each week and letting them rely on that consistently does work quite well. Had the tax cuts expired less money in paychecks would have been the exact wrong prescription for what ails the economy.

    -Gene