Our economy is based on the legacy of tens of thousands of entrepreneurs who built new and innovative businesses and industries. This made our economy the strongest and richest in history — but things are changing. What ever happened to American entrepreneurs in the manufacturing industry and their businesses that drove growth and employment? A combination of tax penalties, proposed new tariffs and growth-destroying policies — as well as a drained talent pool — has set the industry on a steady decline. As a result, the middle class and our country’s GDP have suffered the greatest losses.
The Decline of U.S. Manufacturing
The collapse of the U.S. manufacturing industry over the past 40 years has resulted in the near elimination of national job growth and a dramatic reduction in per capita income — which in turn has taken a terrible toll on GDP growth.
This decline has brought with it the loss of high-quality manufacturing jobs. In 1973, the manufacturing industry provided jobs for 24% of U.S. workers. Today, the U.S. Bureau of Labor Statistics says that number has fallen to approximately 8%, or about 12 million workers. When applied to the size of today’s U.S. labor force, that equates to the reduction of approximately 25 million jobs from the manufacturing sector. Careers in engineering and plant management have been replaced with lower-wage service jobs. People may blame competition from foreign countries for this shift, but the reality is that we lost these jobs years before American companies began to send manufacturing overseas.
A Shortage of Qualified Engineers
One of the ways to begin to reverse the decline of manufacturing is to retain quality engineering candidates in the U.S.
Only 4.4% of American-born undergraduates study engineering. The number of engineering degrees granted to foreign-born students has been steadily increasing since 2007, and many of them are going back to their home countries after getting educated in the States.
Tax Policies That Penalize Business Growth
The unique and flawed way the U.S. tax system calculates taxable profits is starving growth companies of cash and has a devastating effect on new business formation. Changing this could help bring more business back to America and revive our manufacturing sector.
Our tax system is based on accrual rather than cash accounting. As a result, growth manufacturers in particular are severely penalized. This isn’t a matter of a few percentage points. If a company is growing at 25% (adding jobs) and its rate for federal, state and local taxes is 44%, it typically pays an incredible 138% of its cash profits in tax. A similar company with zero growth (not adding jobs) pays 44% of cash profits – the same as its accrual rate. A company shrinking at a 25% rate (and shedding jobs) would only pay 15%. Accrual taxation creates the opposite distortion as well — the faster a manufacturer declines (therefore reducing jobs), the lower its effective tax rate.
Solving this problem would allow thousands of growing, innovative manufacturing startups to thrive, putting us on a path to a sustainable economy and job growth.
The good news is that we don’t have to reduce tax rates to do it (although that is needed also). We simply have to allow companies to pay taxes on a cash basis if they choose, which very small companies already do. This means if a company earns $100,000 in cash profits at the end of the year, they pay taxes on that amount.
The challenge is that this issue is just complex enough that few people in Washington understand it, and the current tax system benefits accountants and bankers while protecting large, entrenched manufacturers from innovators.
Countries like China have gone so far as to apply lower tax rates for high-growth companies, knowing that these are the companies that create growth and — therefore — jobs.
Few successful economies (like the EU and China) have an inheritance tax when a company is passed to the next generation. In light of the U.S. tax issues, it is close to impossible to build a strong manufacturer that is sustainable for the long-term in a single generation. Aside from paying income tax every year, the owners of private companies must pay 35% of market value, which — for a growth company — could easily be 10 to 15 times its earnings. As mentioned above, the faster a company grows, the higher its effective tax rate. Thus, when the time comes, the corporate inheritance tax is so high that the owner is forced to sell, usually adding a great deal of debt — slowing growth and increasing the probability of failure.
Protectionism is not the answer
U.S. Politicians have consistently put forth proposals that include increasing tariffs on imported goods, as well as increasing taxes on companies that purchase raw materials or components from international companies. Increasing duties on imported goods to restore American manufacturing is an overly simplistic approach, which is nothing more than a tax on U.S. consumers, onto whom the increased duty costs will be passed. This also leads to dramatic cost increases for manufacturers, who sources components from low-cost countries. This ultimately reduces overall consumption, GDP growth, and could lead to isolation of the U.S. economy — which is not viable in a global marketplace.
The U.S. has a $12B trade surplus with countries with whom we have free trade agreements, indicating that free trade is a good thing for American manufacturing and the U.S. economy overall. Of the 251,000 manufacturing companies in the U.S., only 3,700 are described as large to medium-sized businesses. Only growing companies add jobs, but if our tax code doesn’t allow our manufacturers to grow, the 98.5% of companies in our manufacturing sector that are considered small businesses will remain small. Government protectionism is not the answer, lowering the tax burden on U.S. manufacturers in order to create an environment where innovative manufacturing companies can start-up and/or grow is the answer. Back to Top