I heard from my good friend Dan Caprio today. Dan is President of the Progress and Freedom Foundation, where I serve as a board member. Dan wrote that he had recently read a report saying that China was repealing some of the tax incentives they put in place to attract capital and asked for the inside skinny on the story.
Like most stories that come out, the one Dan is referring to is about half right. the Chinese authorities have announced a series of tax changes in recent weeks which they refer to as “equalizing” the tax rates paid by domestic and foreign firms to do the same work. Of course with taxes the devil is always in the details so broad answers are not very useful for real businesses.
It’s the story under the story that is interesting to me. China’s growth and foreign direct investment (FDI) over the past 20 years has been heavily dependent on manufacturing. As a result, manufacturing makes up a larger share of Chinese GDP than any other major country.
By one account, half the manufacturing capacity in the world is in China. That has made a tremendous impact on the lives of Chinese people; average incomes have roughly quadrupled since the reforms began almost 30 years ago. But it had also led to worsening air and water quality, a widening rural-urban income gap, and worries over the security of future energy supplies.
China’s government has decided to attack the problems head-on. They are pushing energy conservation. They are increasing energy supplies and investing heavily in renewable energy projects. Both measures are important, but they only buy time. The real answer is their shift of focus from manufacturing to technology to drive growth.
This is where the tax changes come into the argument. China has increased taxes on steel and other heavy manufacturing industries, but has lowered taxes on information and communications technology companies. And they are aggressively courting tech companies to relocate R&D facilities to China with tax breaks and other subsidies. The biggest carrot of all is China’s massive investments in math and science education and aggressive English language education programs.
These are exactly the policies we should be pursuing in the United States. Instead, our Congress couldn’t even pass the telecom reform bill last year that would have triggered billions of dollars in new investment. They failed to pass video franchise legislation that would have allowed a massive rollout of optical fiber to homes. And they flirted with price controls to protect the current market cap of the big internet providers under the misleading heading of ‘net neutrality.” It was a shameful year for US technology policy.
Instead of competing for high-tech capital, we tax and regulate it out of the country–US companies bear a 22% excess overhead load ccompared with overseas competitors. And we tax communications services–the central nervous system of the economy–as if it were a sin to talk with your customer or supplier, or even your family, on the phone. Depending on where you live in America, between 15-30% of your wireless phone bill goes to excise taxes.
Meanwhile in Shanghai last week a pilot project was announced to provide 4G mobile services which would allow selected customers to transmit content at speeds greater than enjoyed by most fiber optic users in the US.
We need to wise up and do the things now to make our technology companies believe they should build their businesses here. We don’t have a lot of time to waste.
JR
JR,
Thanks, I always look forward to your view points and predictions. I have a question for you concerning the future of broadband in the U.S.
With Verizon and AT&T rolling out fios and u-verse broadband nationwide, do you not think that it’s just a matter of time before we move up the ladder with respect to our 16th rank world wide? Both company’s are bypassing Federal legislation flaws and proceeding with individual state legislation for relief. I understand this will slow the process but perhaps at the same time we will reach our goals.
I am not requesting a private email on this issue from you. I would appreciate your thoughts in a future blog. Best Regards ps I am a follower and trust your in site.
Tom,
Yes, sir! I am a big fan of the flat tax idea, not because it is perfect or brilliant, but because it is simple and everyone would know what everyone else is actually paying.
Regarding the tech sector, I believe the big driver is the huge investments on high-speed networks underway in China, India, Vietnam, Brazil, and many other places. That’s great for companies like Cisco, and China’s Huawei, who provide the pieces. I also own shares in mobile carriers in china, where customers are rising fast and should switch from pre-pay to subscriptions.
JR
So, Dr. John, with the challenges posed by the U.S. govt., how are you playing the tech sector?
Also, isn’t what you are writing just another way of saying we need the “Fairtax?”
Tom Paine
Douglas,
Thank you for taking the time to write. I believe that you have touched the live nerve ending of this issue. The tax code is a total mess, as shown by the increasing numbers of middle-income peopole being dragged under the alternate minimum tax (AMT) tent, rather than having their taxes calculated in any rational manner.
Telecom taxes are very high for one simple reason. Communications are so important to people and businesses that they will continue to buy the services, even after their prices have been driven higher by excise taxes. Politicians tax telecom because they can–it is a reliable source of money.
The Federal government is part of the problem, as you point out. Last year Congress finally repealed the $3 per month excise tax that every American paid for long distance service; it had been implemented as a temporary luxury tax to finance the Spanish American War!
The biggest problem, however, is state and local governments that view telecom as a cash cow to be milked whenever they are thirsty. In Los Angeles, for example, telecom is taxed at a much higher rate than beer and alcohol. I have just worked on a research study of this issue and will be writing about it soon.
Regarding federal tax policy, the question you raise is a good one. How can the government collect the funds it needs to run their business? When governors have asked me that question I tell them to tax something that is not likely to move out of your state after you tax it. Today, capital has become almost completely mobile, and costs nothing to move across political boundaries, which makes collecting taxes on capital income very difficult. The converse, of course, is that reducing capital taxes is likely to keep it around. Capital gains and dividend tax collections have more than doubled since the 2003 tax cuts. And , as you point out, the top marginal tax rate, while politically tempting, doesn’t work either. More than 80% of taxes collected at the top rate are paid by small, family-owned, unincorporated businesses–the heart of US job creation.
I agree that we need to sit together like adults and rationally discuss how to create a tax code that makes sense and that people view as fair, so they will actually pay the taxes. And the polarized political environment you write about of Republicans vs Democrats, right vs left, and capital owners vs capital users, is tearing the fabric of the nation apart. I have grown tired of the doctrinal rhetoric from both sides, as I know you have. It’s time for solutions that being people back together again.
JR
John –
In responding to your friend’s query in respect of mew China tax policies you also wrote:
“And we tax communications services–the central nervous system of the economy–as if it were a sin to talk with your customer or supplier, or even your family, on the phone. Depending on where you live in America, between 15-30% of your wireless phone bill goes to excise taxes.”
Isn’t this fact symptomatic of the failed US tax policies, particularly I would argue, under the Bush administration’s policies of shifting the tax burden simply needed to operate the nation’s core governmental functions from the passive, wealth-based income to labor-based, earned income? I am NOT arguing for higher marginal rates per se, but a rational, overhaul of the dangerously antiquated Federal Tax Code?
Some revenue is needed for a great Nation to proceed; we are a Nation of “tax breaks”, accounting gimmicks, and polarizing economic class divisions” that I wish guys like your buddy, the entertaining and pandering, but very intelligent Kudlow would address head-on.
Best regards.
Douglas Duchek
Bloomfield Village, Michigan
Dear Wu Yong,
Thanks very much for writing. I hope it is warm and sunny in beautiful Shenyang today!
You make an important point that I would like people in America to know. The WTO agreements–negotiated on China’s side by my friend Long Yong Tu, the creator of the BOAO Forum–set in motion many of the changes to date. But pressure for reforms from the private sector are replacing the WTO as the principal engine of change in China. And free primary education is going to be a tremendous boost for China’s future.
best,
John
PS: to readers. Wu Yong writes for China Daily, the largest English-language newspaper in China. I read it every day and recommend that you do so too. I am fortunate enough to write a regular op-ed column for China Daily and to have visited their offices in Beijing. Great people. JR
Again, I should say it is really enjoying reading your writing.
But as I know, it has been set five years ago accroding to China’s committment to WTO.
So I belive this is about the pressure from one part of the public(private economy) to push forward the reform.(just like free premary education and cancelling the agriculture taxation)
But I do agree with you that tech is the only way out for China.
One question: What government should do to nurture this besides infrastructure?
Thks
Wu Yong