American manufacturers need tax and regulatory reform, not tariffs

With higher tariffs on electric vehicles and an upcoming election featuring two pro-tariff presidential candidates, the debate over how to best support and strengthen the U.S. manufacturing sector is back. Some wrongly claim that the key to protecting American industry and manufacturing jobs is a set of tariffs on industrial imports. This approach is ultimately counterproductive. There are better ways to help American manufacturing, and one of them is to remove regulatory barriers and reform the tax code.

US tariffs – taxes on Americans’ purchases of imported goods – are touted as a way to “level the playing field” by protecting domestic producers from foreign competition. However, this view ignores the fact that tariffs raise costs not only for consumers but also for U.S. businesses that use imports as input for production. Moreover, tariffs disrupt supply chains and cause trading partners to impose retaliatory tariffs on our exports.

More importantly, the tariffs do little to address the underlying factors that make it difficult for U.S. manufacturers to compete in the global marketplace. Instead, manufacturers need a more supportive regulatory and tax environment. It should be obvious that excessive regulation places significant burdens on businesses, increasing compliance costs, stifling innovation and making it more difficult for businesses to adapt to changing market conditions.

And boy, does production suffer from excessive regulation. From environmental regulations such as the Environmental Policy Act, to labor regulations such as the Occupational Safety and Health Act, to consumer protection and product safety regulations, to financial and accounting regulations such as the Sarbanes-Oxley Act, manufacturers in America faces unnecessary burdens.

In a recent article titled “Industrial Obstacles: Reducing the Regulatory Burden on U.S. Manufacturers,” published in the May 2024 Club for Growth Policy Handbook, economist Daniel Ikenson writes: “For manufacturing companies, the cost of federal regulation in 2022 was approximately $350 billions, or 13.5% of the sector’s GDP – a burden 26% greater than the inflation-adjusted cost of compliance in 2012.”

He adds that while the average U.S. company pays $13,000 per employee for compliance, large manufacturers incur costs that are more than twice as high – $29,100. However, even some small manufacturers face annual compliance costs of $50,100 per employee. This helps explain why manufacturing automation is so popular and why our fastest-growing companies are in the technology sector rather than the manufacturing sector.

You may wonder how small producers even stay in business.

Yet one thing is certain: American manufacturers continue to be successful. This is remarkable considering they are so heavily burdened by government regulations. Ikenson reminds us that “despite the various, cumulative burdens placed on U.S. manufacturers… in 2022, “real manufacturing GDP” reached a record high of $2.28 billion. The sector’s value added per employee also reached a record high of almost $142,000, 50% higher than second-place South Korea.”

Imagine America’s industrial might with streamlined and simplified regulation. By maintaining necessary protections for workers, consumers and the environment, the government can reduce barriers to entry and growth for manufacturers. Many countries have taken real steps in this direction.

Additionally, simplifying and making the tax code more transparent would provide a significant boost to the manufacturing sector. In the textbook’s chapter, Erica York of the Tax Foundation explains that our tax code penalizes capital-intensive sectors like manufacturing. Capital investments such as machinery and equipment are subject to excessively long depreciation schedules for tax purposes. These schedules often require companies to deduct the costs of these investments over an extended period of time, which may be much longer than the useful life of the assets. As a result, manufacturers may not be able to fully recover the costs of their investments in a timely manner by drawing down capital that could otherwise be used for development or innovation.

U.S. tax laws often put domestic producers at a disadvantage compared to their foreign counterparts. Some countries, including China, offer more favorable tax treatment for capital investments, such as faster depreciation schedules or more generous spending regulations, making investing in these jurisdictions more attractive for businesses. By lowering corporate tax rates, allowing capital investments to be fully and immediately spent, and reducing the tax burden, the government can boost economic growth. Tariffs only make such efforts more difficult.

Instead of erecting trade barriers, policymakers should focus on creating an environment more conducive to production growth and competitiveness. This is where America falls behind. It’s time to do more with it.