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Is Santorum Right? Should We Pick Manufacturing Over Other Industries? (UPDATE)

Countries frequently believe that they can achieve prosperity by government aiding one particular promising industry over others. They promise increased growth and greater employment if only the government aids the chosen industry. But as the government supports one industry, it does so at the expense of other industries that might have been created. Money that would have flowed to a variety of potentially beneficial projects is redirected–either by force or “incentives”

Jobs are created in the subsidized industry. However, the prosperity government planners promise does not materialize because the industries that would have grown are deprived of funds and languish. The government planners could not foresee which industries will grow (and may not care if it serves a political purpose). Countries that choose this approach have seen few successes and far more catastrophes.

The reason centralized, government winner-picking approaches so frequently fail is not just because the government picks the wrong industry to support. No, when governments make their choice, the country’s leaders create bureaucracies and legislation directing the country’s limited resources into the government’s chosen path. Should circumstances change and the projections of the government experts prove to be incorrect, or other opportunities arise; the country is slow or unable to adjust. In economic theory, this is called “path dependency”.

Stalin’s Russia picked manufacturing over its other industries, Asian governments picked memory chip production over other goods, politicians in US picked housing over other sectors of the economy, and Obama picked one particular solar cell type over other energy sources. All these picks proved to be wrong. Industries deprived of funds were unable to create the future and the people suffered—Suffered at the whims of government officials who were supposed to serve them.

So is Santorum picking winners and losers like a central planner? I have read a lot of comments here on Redstate concerned that Santorum is doing just that. They believe that his proposed 0% tax on manufacturing corporations, favors manufacturers at the expense of other industries. The thinking is that by lowering taxes on manufacturers, taxes must be higher on other industries thus discouraging production in these other industries and forcing the US on one path (manufacturing) and inhibiting our ability to pursue more profitable industries. As we have seen, concerns over a country creating a path dependency by picking winners and losers are justified –if there were no other economic considerations.

If there were no other considerations, Santorum’s policy of focusing on manufacturing would be of grave concern. However, there are other factors to consider. While economists agree that discriminatory government policies may create dangerous path dependencies, they also agree that tax policy should be directed in a way that:

1) Generates revenue with the fewest distortions and
2) Creates the least amount of damages or unintended consequences.

Our high corporate tax rates have caused corporations around the world to avoid locating in the US, but some industries more than others. Certain industries are more sensitive to differences in world tax rates than others. Pharmaceutical companies still locate in the US because the access to research centers is worth the higher tax rates imposed. However, the benefits of locating in the US do not always outweigh the costs imposed by our tax system.

Manufacturing is, by its nature, very competitive and in our global marketplace the benefits of locating in one country over another may be very small. As such, our high tax rates may, be killing this industry. If this is true, lower (or even 0%) tax rates on manufacturing (even at the expense of higher rates on other industries), may result in stronger growth and even greater tax revenues than our current system (even though under Santorum’s plan the corporate rate is 0%, those who own the stock will pay taxes as will the employees) Santorum expresses this logic well when he states:

“Why are we going to treat retailers and Wal-Mart and restaurants and florists different than we treat manufacturers? Because retailers don’t move their operations to China. They don’t move them to Mexico. Because we have to compete for those jobs, and if we don’t effectively compete, we lose those jobs”

Additionally, manufacturing industries also create good paying jobs at all skill levels. People currently requiring public assistance might instead be employed in jobs that relieve the public doles. Thus, rather than harming the economy, Santorum’s plan could shrink the size of government and bring in greater tax revenues. Therefore, while some might consider Santorum’s plan unfair to non-manufacturers, we conservatives should remind ourselves of one simple principle:

Taxes should be imposed not for the purposes of fairness but to raise tax revenue in the most effective manner possible.

UPDATE: Several posters have asked these questions: 1)How are taxes damaging and what damage is done by taxes? 2) Don’t taxes harm every industry the same?

# 1

Taxes are damaging because they can create job losses, lost opportunities, and reductions in people’s happiness. Taxes can cause trades that would have taken place not to take place. Taxes artificially increase the cost to a firm (or consumer). These increased costs may cause the producer to decide not to produce the good or cause the consumer to not purchase the good resulting in firms not hiring as many workers and consumers not getting the benefit of the good.

Income taxes discourage people from investing in new businesses (or having the money to doing so) because if the government gets to keep a portion of those profits, the investor may decide the risk is not worth the reduced reward. Income taxes also discourage people from working as much because it reduces the reward to their labor efforts.

US corporate tax rates are the highest in the world and we even tax overseas earnings of companies that dare locate in the US. These taxes are VERY damaging. Companies that might have located here decide to locate elsewhere in the world. Jobs are not created in the US and more people are put on public doles.

So yes taxes are very damaging. Sometimes they are needed because the damage created by the tax are outweighed by the benefits received when the government spends this money wisely (We are better off because the government fought WWII even if it did damage the markets taxed)

#2

Taxes do not harm every industry by the same amount. Take an extreme example. Suppose a small country has two industries: Gold mines and manufacturing. Suppose we tax all corporations that in this small country at the same rate of 35%. (Liberal Mecha) Will the gold mines shut down? Probably not. The gold is only located within that country and while they do not want to pay the taxes, it may still be worth extracting the gold even at this high tax rate. But what about the manufacturing industries? Imagine that they produce goods that are sold around the world and not just within the taxing country. Manufacturing companies may have chosen to locate within this country because it offered a slight cost advantage. But now that the manufacturer has to pay 35% of their profits to the government. The slight cost advantage will now be overwhelmed by the increased tax rate. The manufacturers will leave causing unemployment, lost opportunites for trade, and if there is a social safety net more people on the public dole.

Such a uniform tax rate would not only be devastating but it would also be cruel to the people who were thrown out of work by the government’s actions. Since revenue needs to be raised, the question is what is the best way to raise that revenue doing the least harm to consumers, producers, and employees.

Of course the best option is to reduce government spending so taxes do not need to be as high and so burdensome. I believe both Santorum or Gingrich would reduce spending more than Romney. Thus taxes under either of them can be lower and less burdensome.

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