WASHINGTON, December 3, 2016 – President-elect Donald Trump recently made the Carrier Corporation an offer they couldn’t refuse. Carrier was prepared to move some of their production out of Indiana and into Mexico, which would have resulted in as many as 1100 people losing their jobs. Trump stepped in and offered the company a deal that will cost taxpayers about $7 million because of tax breaks given to Carrier.
Is there a better way to keep jobs in the US?
The reason Carrier considered moving to Mexico was purely economic. Because wage rates in Mexico are a fraction of wage rates in the US and because the Mexican government has few costly manufacturing regulations, Carrier reasoned they could produce cooling units in Mexico at a much lower cost than in the US. Plus, Mexico has a lower corporate tax rate.
The lower manufacturing cost in Mexico would allow Carrier to successfully compete against other manufacturers who produce their units in countries where the cost advantage is considerable. Carrier was fearful of losing sales and perhaps incurring losses, by continuing to produce in the US. The stockholders of Carrier’s parent company, expect the Carrier to be profitable.
Trump reasoned that if $7 million in tax incentives were given to Carrier that would improve their profitability enough so that the move to Mexico wouldn’t make sense. And it appears to have worked. This arrangement is not unusual. Many county and state governments give employers tax incentives to locate in their city or to create jobs. Most voters tend to favor these actions.
The government reasons that the tax breaks can be viewed as an investment in the future. In Indiana, the $7 million in lost tax revenue from the Carrier deal should be more than made up by the taxes paid by the 1100 workers who jobs were saved and by the increased economic activity generated from the spending of those 1100 workers who may have left the area without this deal.
Some argue this looks like crony Capitalism. Others argue that this is not a market solution and in fact causes market distortions. Is there a better way?
“Companies are not going to leave the U.S. anymore without consequences,” Mr. Trump said at a Carrier Corp. furnace plant in Indianapolis. “Leaving the country is going to be very, very difficult.”
Trump is right, in that he can create an environment where it will be very, very difficult to leave the US. There is a free market approach to solving this problem that eliminates any hint of crony Capitalism. Frankly this solution is what most of his supporters thought he would follow.
If a cost disadvantage exists for companies to manufacture in the US, then the government should do what it can to eliminate the disadvantage without distorting markets or favoring any specific company. The first step is relatively easy and one that Trump has already promised. That is to change the corporate tax rate.
The corporate tax rate in Mexico is 30%. The corporate tax rate in the US on marginal income for large corporations is 39%. Add in the much higher labor cost in the US and the large number of costly and burdensome regulations implemented particularly within the last 8 years, and it becomes very costly to produce in the US when compared to producing in Mexico. And because of NAFTA, there are no penalties placed on US companies producing in Mexico.
The easy solution, as Trump has suggested, is to lower the corporate tax rate to 15%. That move alone may be enough to increase the bottom line of companies like Carrier so that there is no economic advantage to relocating outside of the US. While some opponents argue that this will reduce tax revenue and is therefore very costly, that may not be true.
Suppose the US keeps the tax rate at 39%. Companies will be encouraged to manufacture in Mexico for purely economic reasons. So, let’s say the companies generate $1,000 in taxable income. If they are taxed at 39% that generates $390 of revenue. But if the tax rate was cut to 15%, companies would stay in the US and in fact some foreign manufacturers would be induced to produce here. Eventually that could triple taxable income.
Tax revenue to the federal government would be 15% of $3,000 or $450. The lower tax rate, would eventually lead to increases, not decreases in tax revenue.
Along with lowering the corporate tax rate, repealing burdensome and costly regulations would also increase the incentive to produce in the US. This is what a free market solution looks like. These actions cause no market distortions, don’t cost taxpayers anything in the long term, would be a growth oriented policy, would reduce unemployment and would be acceptable to Trump’s supporters.
Then Trump will be right. “Leaving the country is going to be very, very difficult.”