# Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/crs%3AR42742

## Record

- **Collection:** Congressional research report
- **Document type:** CRS Report
- **Published:** August 3, 2015
- **Citation:** R42742

## Text

Federal Tax Benefits for Manufacturing:
Current Law and Arguments For and Against
-name redactedAnalyst in Public Finance
August 3, 2015

Congressional Research Service
7-....
www.crs.gov
R42742

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Summary
Fueled in part by certain policy initiatives advocated by President Obama, a lively debate over
whether additional federal assistance should be provided for manufacturing is taking place among
some analysts and lawmakers. Several issues are central to the debate: (1) the contributions of
manufacturing to the performance and growth of the U.S. economy, (2) whether the federal
government should do more to promote the growth of the sector, and (3) if so, what measures
would be likely to have the intended effect?
The federal government supports manufacturing in a variety of ways. This report focuses on the
support provided through the federal tax code. Current federal tax law contains nine provisions
with the potential to provide significant tax relief to firms primarily engaged in manufacturing. A
few are targeted at manufacturing, while the others offer more benefits for manufacturers than for
firms in most other sectors. The most important provisions, ranked on the basis of estimated
foregone revenue, are the deferral of the active income of controlled foreign subsidiaries of U.S.based corporations, the research tax credit, the expensing of outlays for research and
experimentation, and accelerated depreciation for a variety of capital assets.
A number of proposals are being considered in the 114th Congress to expand federal tax benefits
for the manufacturing sector. Some of the bills would create new tax incentives intended to
increase domestic investment and job growth in manufacturing. Their prospects for passage have
become intertwined with the growing debate in Congress over reforming the federal tax code.
Most proponents of tax reform favor an approach that would combine a broadening of the income
tax base (e.g., by eliminating certain business tax incentives) with a lowering of corporate and
individual tax rates, in a revenue-neutral fashion. Such an approach could have a significant effect
on the taxes paid by many manufacturing companies.
Proponents of boosting federal assistance for manufacturing say the added support would benefit
the U.S. economy in several important ways. In their view, a revitalized manufacturing sector
might enable the United States to derive more of its economic growth from exports and domestic
production than it has in the past two decades or so. Proponents also contend that average
domestic wages would be likely to rise in response to growing manufacturing output, as
manufacturing jobs historically have paid higher wages and benefits, on average, than have nonmanufacturing jobs. In addition, according to proponents, a growing manufacturing sector would
help lay a foundation for future U.S. economic growth, since manufacturing industries perform
the vast share of private-sector research and development (R&D), which fuels the innovation that
serves as a primary engine of economic growth. Finally, proponents argue that the United States
would lose its long-standing leadership in advanced manufacturing technologies in the absence of
increased federal support for manufacturing R&D and worker training.
Critics of greater federal assistance for manufacturing maintain that there is no economic
justification for additional support. In their view, in the absence of a market failure linked to
goods production in general, government aid for manufacturing should be decreased or
eliminated, not increased. Critics also say that promoting job growth in manufacturing would do
little to create the millions of jobs needed to bring domestic full-time employment back to the
levels that prevailed on the eve of the severe recession from 2007 to 2009. And, say critics, U.S.
gross domestic product and employment would receive a greater boost from federal initiatives to
dismantle foreign barriers to expanding exports of services than from targeted assistance aimed at
boosting the competitiveness of U.S. manufacturing companies.

Congressional Research Service

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Contents
Introduction...................................................................................................................................... 1
Manufacturing and the U.S. Economy............................................................................................. 2
Federal Policy and the Manufacturing Sector.................................................................................. 6
Non-Tax Assistance ................................................................................................................... 6
Tax Assistance ........................................................................................................................... 7
Arguments For and Against Federal Support for Manufacturing .................................................. 13
Argument for Targeted Government Assistance for Manufacturing ....................................... 14
Driver of Export Growth ................................................................................................... 14
Source of Relatively High Wages and Benefits................................................................. 15
Critical Source of New Commercial Technologies ........................................................... 15
Major Player in the Development of Clean-Energy Technologies .................................... 16
Linkages to Other Industries ............................................................................................. 16
Other Developed Countries Support Manufacturing......................................................... 17
Intended Recipients of Government Support .................................................................... 18
Arguments against Targeted Government Assistance for Manufacturing ............................... 19
Absence of Any Market Failure ........................................................................................ 19
Shrinking Source of Job Creation ..................................................................................... 21
Promoting Service Exports Would Do More to Stimulate the Economy .......................... 22
Implications of the Arguments for Federal Policy toward Manufacturing .............................. 22

Figures
Figure 1. Key Economic Indicators for Manufacturing, 1960 to 2010 ............................................ 3

Tables
Table 1. Percentage Change in Full-Time-Equivalent (FTE) Employment and Real Value
Addeda for Major U.S. Manufacturing Industries, 1998 to 2013.................................................. 5
Table 2. Federal Tax Provisions That Provide Significant Benefits to Manufacturing
Firms ........................................................................................................................................... 10

Contacts
Author Contact Information........................................................................................................... 24

Congressional Research Service

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Introduction
In his 2013 State of the Union speech, President Obama stated that “our first priority is making
America a magnet for new jobs and manufacturing.”1 The President was signaling that a
revitalized manufacturing sector was a key element of his strategy for promoting faster U.S.
economic growth.
Recent calls to use government policy to revive the U.S. manufacturing sector, particularly the
companies involved in developing and making advanced technology products, have re-kindled a
debate among lawmakers, economists, and other analysts over the desired economic role of
manufacturing and the proper role of the federal government in the sector’s performance. In the
current policy debate, differences of opinion have emerged that evoke the conflicting views that
characterized the domestic debate over industrial policy in the late 1970s and early 1980s. Back
then, proponents of government policies to promote the competitiveness of U.S.-based
manufacturing companies argued that such support was warranted for two reasons. First,
manufacturing contributed more to the performance and growth of the U.S. economy than any
other sector. Second, the competitive gains made by foreign companies in a range of industrial
markets in the 1970s and early 1980s were partly due to government support in their countries of
origin.
But some saw little or no merit in that argument. In their view, what mattered most for future
growth in jobs, real wages, and output was not government support for so-called strategic
industries but public investments in the main forces propelling rises in the standard of living in
the long run: worker skills, education, research and development (R&D), and the economic
infrastructure. These critics said that industrial policies were unlikely to succeed because civil
servants in general were no match for businessmen in identifying the new technologies that had a
significant potential to generate large numbers of well-paying jobs in coming years.
The question of what role federal policy should play, if any, in reviving manufacturing has reemerged as a policy issue in the 114th Congress, especially in the context of proposals to reform
the federal income tax. Some critics of the current federal income tax contend that existing tax
benefits for manufacturing underscore a critical problem with the system: that it is laden with
special benefits that unevenly reduce effective tax rates and have the same budgetary effects as
federal spending, except that the benefits are not subject to the scrutiny and oversight built into
the congressional appropriations and authorization processes.
This report examines the provisions in current federal tax law that benefit most or many
manufacturing firms.2 More specifically, it identifies and describes those provisions and discusses
1

See https://www.whitehouse.gov/the-press-office/2013/02/12/remarks-president-state-union-address.
Federal support for manufacturing is spread among several agencies and lacks centralized control and coordination.
The Department of Defense funds research on new product and process technologies through its Manufacturing
Technologies Program and the Defense Advanced Research Projects Agency. Under its Industrial Technologies
Program, the Department of Energy enters into partnerships with industries to improve their energy efficiency through
the development of new process technologies. The National Institute for Standards and Technology (NIST) devotes
about half of its annual budget to promoting improved competitiveness among small and medium-sized manufacturing
companies through two programs: the Manufacturing Extension Partnership and the Engineering Laboratory. NIST also
supports research in advanced manufacturing technologies through the Advanced Manufacturing Technology Consortia
Program and the NIST Centers of Excellence program. In addition, the Obama Administration is proposing that
Congress appropriate $1 billion through the NIST budget for a competitive grant program to establish a network of
(continued...)
2

Congressional Research Service

1

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

the main arguments for and against targeted federal support (tax and non-tax) for the
manufacturing sector. To set the stage for these topics, the report begins with brief overviews of
the economic contributions of the sector and existing federal non-tax support for manufacturing.
The report will be updated as warranted by changes in federal tax law.

Manufacturing and the U.S. Economy
According to the North American Industrial Classification System (NAICS), the manufacturing
sector consists of establishments that are primarily engaged in the transformation of materials,
substances, or components into products.3 Establishments in this case are the factories, plants, or
mills that use power-driven machines and equipment to effect this transformation. But they also
include individuals who transform materials, substances, and components into products by hand
in their homes, as well as the multitude of small businesses that sell directly to the public items
they make on their premises.
In general, the products made in manufacturing establishments are finished or semi-finished. The
former are ready for consumption or final use, while the latter serve as inputs for the production
of finished products. In the U.S. national income accounts, manufacturing is broken down into a
series of sub-sectors (or industries) that reflects the links among companies as a result of the
production process. Basically, the output of some manufacturing companies becomes the inputs
of others and vice versa. For example, makers of machine tools buy needed materials and
components directly from producers of these items, and in some cases, the latter purchase
machine tools from the former so they can produce those materials and components.
Nonetheless, the economic boundaries between manufacturing and other sectors sometimes are
not clearly drawn, or even confusing. For example, the bottling and processing of milk and
spring-fed water are regarded as manufacturing activities under the NAICS, although they
involve no transformation of materials or components into a new product. On the other hand, the
erection of an office building (including any fabrication performed at construction sites) is
considered a construction activity, even though the final product is the result of a substantial
transformative process.
Manufacturing’s role in the U.S. economy has changed considerably since 1960. Back then, it
accounted for 27% of real gross domestic product (GDP), 31% of non-agricultural employment,
more than 20% of domestic non-residential fixed investment, nearly 99% of business investment
in research and development (R&D), and 62% of exports. Since the 1970s, however, the
manufacturing sector’s economic contributions have declined sharply.
The extent of this decline can be seen in Figure 1. Basically, it tracks the manufacturing sector’s
share of non-agricultural employment, gross domestic product (GDP), business investment in
research and development (R&D), exports, and domestic investment in capital assets between
(...continued)
regional institutes for manufacturing innovation. In addition, the National Science Foundation funds a significant share
of the federally supported basic research done at American colleges and universities. Some of the research funded by
NSF has applications in manufacturing; those funds are distributed largely through the Directorate for Engineering’s
Civil, Mechanical, and Manufacturing Innovation Organization.
3
See http://www.census.gov/cgi-bin/sssd/naics/naicsrch?code=31&search=2012 NAICS Search.

Congressional Research Service

2

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

1960 and 2010. Relative to 1960, manufacturing’s share of exports in 2010 was 17% lower; its
share of business R&D investment 29% lower; and its contribution to non-agricultural
employment 71% lower. Except for non-agricultural employment, manufacturing’s share shrank
because the contributions of other sectors rose faster than those of manufacturing. In the case of
employment, manufacturing’s share declined because it lost workers while combined
employment in other sectors grew, except during recessions of course.
Figure 1. Key Economic Indicators for Manufacturing, 1960 to 2010

Source: Congressional Research Service using data obtained from the Department of Commerce, the
Department of Labor, and the National Science Foundation

Every indicator in Figure 1 trended downward except one: employee wages and salaries. Labor
compensation per employee in manufacturing was somewhat larger in 1960 than it was in most
other sectors. That gap grew steadily until the mid-1990s; by 2010, it was 7% smaller than in
1995, but nearly 18% larger than in 1960. Still, wages and benefits were consistently higher in
manufacturing than they were in several other sectors (e.g., construction, mining, transportation,
and utilities) from 1960 to 2010.
Several trends related to the ones shown in Figure 1 are worth noting. First, among all sectors,
manufacturing held the largest share of GDP (measured in current dollars) until 1986, when the
government sector’s share surpassed it. Several other sectors have risen in importance since then,

Congressional Research Service

3

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

and in 2010, government, finance, insurance, real estate, rental and leasing; and professional and
business services each had larger shares than manufacturing.
Second, manufacturing had the largest share of non-agricultural employment among all sectors
until 1989, when employment in the government sector topped employment in manufacturing.
Since then, retail trade, professional and business services, education, health services, and leisure
and hospitality have joined government as larger sources of employment than manufacturing.
Third, although payroll employment in manufacturing has fallen gradually since 1979, when it
reached an all-time peak of 17.985 million, the sector’s value added (in current dollars), which
measures its contribution to GDP, grew by a factor of 11.9 from 1960 to 2013, when it reached an
all-time peak of $1.8 trillion.
The divergent trends in manufacturing’s contribution to GDP and its employment reflect the
relatively robust labor productivity growth in recent decades within the manufacturing sector.
From 1990 to 2000, output per hour of labor in manufacturing rose at an average annual rate of
4.3%, compared to a rate of 2.2% in all non-farm businesses.4 The gap narrowed from 2000 to
2007, when the rate of growth for manufacturing fell to 3.7%, while the rate for the non-farm
business sector rose to 2.6%. There was little difference between the two growth rates between
2007 and 2013: labor productivity grew at an average annual rate of 1.6% in manufacturing and
1.5% in non-farm businesses.
Figure 1 also does not address the diverse outcomes among manufacturing industries from 1960
to 2010. Depending on how finely the manufacturing sector is sub-divided, many different
industries can be identified and analyzed. Under the NAICS, which federal agencies use to
organize and report industry data, manufacturing encompasses durable goods and non-durable
goods industries, and each group, in turn, is divided into 10 major industries. The performance of
these 20 industries can be evaluated using some of the same indicators of economic importance.
A comparison of the change in full-time-equivalent (FTE) employment and real value added from
1998 to 2013 for major manufacturing industries reveals that their performance was remarkably
uneven. Some grew or declined in importance more than others.5 As the figures in Table 1 show,
FTE employment fell over the period in each of the industries, but the extent of the decrease
ranged from -7.2% for food, beverages, and tobacco products to -75.9% for apparel, leather, and
similar products. The range was even greater for real value added. Of the 20 industries, real value
added decreased for eight of them and increased for the other 12 between 1998 and 2013. The
decreases ranged from -7.0% for plastics and rubber products to -50.2% for apparel, leather, and
similar products, while the increases extended from 1.5% for printing and related support
activities to 561.2% for computers and electronic products. Rising foreign competition,
offshoring, and the growth of the information economy were among the key forces driving these
changes.

4

See http://www.bls.gov/lpc/prodybar.htm.
The comparison does not stretch back before 1998 because that is the first year for which the Bureau of Economic
Analysis at the Commerce Department provided an estimate of FTE employment by industry.
5

Congressional Research Service

4

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Table 1. Percentage Change in Full-Time-Equivalent (FTE) Employment and Real
Value Addeda for Major U.S. Manufacturing Industries, 1998 to 2013
Change in FTE Employment

Change in Real Value Added

Manufacturing

-31.9%

30.1%

Durable Goods Production

-31.2%

38.1%

Wood Products

-42.5%

-11.6%

Non-Metallic Mineral Products

-31.4%

-23.3%

Primary Metals

-38.1%

28.5%

Fabricated Metal Products

-18.8%

-17.9%

Machinery

-26.5%

4.8%

Computers and Electronic Products

-42.0%

561.2%

Electrical Equipment, Appliances, and
Components

-37.7%

4.1%

Motor Vehicles and Parts

-34.9%

52.3%

Other Transportation Equipment

-15.1%

20.7%

Furniture and Related Products

-45.2%

-33.7%

Miscellaneous Manufacturing

-22.2%

37.0%

Non-Durable Goods Production

-33.0%

-0.3%

Food, Beverage, and Tobacco
Products

-7.2%

7.4%

Textile Mills and Textile Products

-65.3%

-47.3%

Apparel, Leather, and Similar
Products

-75.9%

-50.2%

Paper Products

-41.1%

-35.5%

Printing and Support Activities

-43.0%

1.5%

Petroleum and Coal Products

-9.1%

9.1%

Chemical Products

-19.3%

19.4%

Plastics and Rubber Products

-29.5%

-7.0%

Source: Compiled CRS from data obtained from the Bureau of Economic Analysis, U.S. Department of
Commerce; see http://www.bea.gov/iTable/iTable.cfm?ReqID=5&step=1 for more details.
a.

Value added for an industry measures its contribution to gross domestic product. It is equal to the sum of
labor compensation, taxes on production, imports less government subsidies, and gross operating surplus.
Basically, value added represents the difference between an industry’s gross output (consisting of sales or
receipts and other operating income, commodity taxes, and inventory change) and the cost of its
intermediate inputs, including energy, raw materials, semi-finished goods, and services purchased from all
sources.

Congressional Research Service

5

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Federal Policy and the Manufacturing Sector
Federal support for manufacturing encompasses a number of tax and non-tax subsidies. The tax
benefits are discussed in the following section, while this section describes the other kinds of
assistance.

Non-Tax Assistance
Several federal programs assist manufacturing firms of all sizes outside the federal tax code.6 The
assistance mostly focuses on workforce training, export promotion, business counseling, and
technology development. Foremost among the programs are the Department of Commerce’s
(DOC) National Institute of Standard’s (NIST) Hollings Manufacturing Extension Partnership
program (MEP), which was established in 1988 and provides technical assistance to small and
medium-sized manufacturers to help them become more competitive and productive, and the
Advanced Manufacturing Partnership (AMP), which was launched in June 2011 and uses federal
funds to leverage the creation of partnerships among businesses, universities, and federal,
regional, and state government agencies for the purpose of developing and encouraging the use of
advanced manufacturing technologies.
A variety of other programs with smaller budgets at DOC, the Department of Energy (DOE), the
Department of Defense (DOD), and the National Science Foundation (NSF) also support
manufacturing, mainly by fostering the development of new manufacturing technologies tailored
to the missions of those agencies.
There is no readily available estimate of the total amount of federal spending on non-defense
programs to support the manufacturing sector. Generating such an estimate is difficult in part
because the support is delivered through direct and indirect channels. Direct support comes in the
form of programs that target most or all of their resources to manufacturing firms. A case in point
is the MEP, which provides technical assistance to small and medium-sized manufacturing firms
only. As a result, it is relatively easy to determine the amounts budgeted or spent through the
program.
But such is not the case with all the federal programs that indirectly support manufacturing. The
main difficulty lies in accounting for the dollar value of such support, which can be defined as
federal industrial assistance that is not targeted at manufacturing but nonetheless benefits a
significant number of manufacturers. No such problem arises in the case of the research tax credit
under section 41 of the federal tax code. Although it is not limited to manufacturing firms, they
are by far the biggest users of the credit among all sectors. Data on claims for the credit by
industry and sector are available through the IRS website. But a similar breakdown does not exist
among the programs administered by the Small Business Administration (SBA). While many
small manufacturers have benefited from those programs over the years, it is unclear to what
extent.
Still, lawmakers might find it useful to have an accurate and detailed breakdown of non-tax
federal support for manufacturing that has nothing to do with national defense.
6

See Nisha Mistry and Joan Byron, The Federal Role in Supporting Urban Manufacturing, Brookings Institution, Pratt
Center for Community Development, April 2011, p. 34.

Congressional Research Service

6

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

The bulk of direct federal non-tax support for manufacturing appears to consist of funding for
research and development (R&D). According to the most recent figures on industry spending on
R&D issued by the NSF’s National Center for Science and Engineering Statistics, the federal
government funded an annual average of $24.4 billion of the defense and non-defense R&D
performed by U.S. manufacturing companies in 2011 and 2012.7 Moreover, President Obama’s
FY2016 budget request for federal R&D calls for $2.4 billion for R&D targeted at advanced
manufacturing technology; this support that would be delivered through programs at NSF, DOE,
DOD, DOC, and other federal agencies.8 If enacted, MEP would receive $130 million and $15
million would go to fund the activities of advanced manufacturing technology consortia.9 The
proposal includes funding to continue the construction of a national network of 45 manufacturing
innovation institutes over 10 years. Nine institutes have been funded so far, and the proposal calls
for spending $150 million in FY2016 to establish another seven such institutes. Each focuses on
developing and commercializing different manufacturing technologies with broad applications
through the collaborative efforts of local companies, universities, and technical institutes, and
federal agencies.10

Tax Assistance
Before examining current federal tax assistance for manufacturing in detail, it is useful first to
explain what a tax preference is. Such a preference (which many also refer to as a tax break, tax
benefit, or tax expenditure) is a provision in the federal tax code that grants special tax relief to
eligible individual or business taxpayers. The tax relief is mainly intended to promote certain
policy goals. For instance, the tax credit under section 41 for increasing research expenditures
seeks to increase U.S. investment in innovation, a crucial source of long-term economic growth
and a key element in the competitiveness of U.S. businesses that compete with foreign companies
in domestic and foreign markets. In some cases, however, the tax relief is intended to help
struggling businesses improve their financial condition. Regardless of intent, the tax reduction
from the preferences is considered special because it represents a departure from what the
Congressional Budget and Impoundment Control Act of 1974 (P.L. 93-344) calls “normal income
tax law.”
Tax preferences can take any of the following forms: (1) exclusions, exemptions, or deductions,
which reduce an eligible taxpayer’s taxable income; (2) preferential tax rates, which apply lower
rates to some or all of an eligible taxpayer’s taxable income; (3) credits, which reduce an eligible
taxpayer’s tax liability; and (4) tax deferrals, which postpone the recognition of income for tax
purposes or accelerate the recognition of expenses that normally should be deducted in future
years.
All things being equal, tax preferences also reduce the tax revenue flowing into the U.S. Treasury.
For any tax preference, that revenue stream would be larger if the preference did not exist. As a
7
Raymond M. Wolfe, Business R&D Performed in the United States Tops $300 Billion in 2012, InfoBrief, National
Center for Science and Engineering Statistics (Arlington, VA: Oct. 2014), table 2, p. 2.
8
See Office of Management and Budget, Fiscal Year 2016 Budget of the U.S. Government: Analytical Perspectives
(Washington: GPO, 2015), p. 293.
9
See CRS Report R43908, The National Institute of Standards and Technology: An Appropriations Overview, by (name
redacted), Appendix B, p. 20.
10
For more details on the National Network for Manufacturing Innovation, see CRS Report R42625, The Obama
Administration’s Proposal to Establish a National Network for Manufacturing Innovation, by (name redacted)

Congressional Research Service

7

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

consequence, budget experts tend to view tax preferences as federal spending through the tax
code. This explains why tax preferences are also known as tax expenditures. Some contend that
permanent tax preferences operate in the same way as entitlement programs do: in both cases,
benefits are distributed or paid to qualified persons or corporations with no time limit.11
The federal tax code contains numerous provisions granting preferential treatment to companies
in a range of industries. In recent years, congressional oversight of business tax benefits generally
has been limited to periodic legislation to extend certain temporary benefits that have expired or
are about to expire. Permanent business tax benefits, by contrast, have received less attention.
Table 2 shows the tax preferences from which manufacturing companies derive the most benefit.
The figures apply to corporate and non-corporate businesses. Since not every tax preference is
designed to benefit manufacturing firms only, two methods are used to identify the most
beneficial preferences. One is the share of the total amount of claims for a tax preference
accounted for by manufacturing firms. The other is the design of a preference and the extent to
which manufacturing firms as a whole would be likely to benefit from it, given their lines of
business. Of the tax preferences listed in Table 2, only one arguably is designed to benefit the
manufacturing sector more than others: the deduction for “domestic production activities” income
under Section 199 of the federal tax code. While companies in several other industries benefit to
varying degrees from the deduction and the other preferences shown in the table, it is likely that
they do not benefit to the same extent as do firms primarily engaged in manufacturing activities.
Several of the tax preferences are intended to stimulate increased investment in qualified research
(Sections 174 and 41) and in equipment and software (Sections 168 and 179). They do so by
reducing the cost of capital and boosting cash flow for firms undertaking such investments. Tax
subsidies for investment in research are justified on the grounds that they seek to correct a market
failure associated with R&D investment. In theory, companies are assumed to invest too little in
research and development (R&D) relative to its social returns, because they cannot capture all the
returns. But a similar rationale may not apply to tax subsidies for capital investment. Economists
have found no evidence indicating that investment in capital assets like factories and equipment is
subject to a similar market failure; rather, firms generally appear to capture most of the returns.
Governments typically have adopted investment tax subsidies as a countercyclical measure
during economic downturns. The federal government did so in response to the Great Recession of
2007 to 2009 by extending and increasing the bonus depreciation allowance under Section 168(k)
and enhancing the expensing allowance under Section 179.
With one exception, the other tax preferences shown in the table encourage the following
activities: increased domestic investment and expansion by manufacturing firms (Section 199); a
larger flow of equity capital to small, young manufacturing firms (Section 1202); greater cash
flow among manufacturing firms of all employment sizes (Sections 491, 492, and 168(k)(4)); and
increased U.S. exports of manufactured products (Sections 861, 862, 863, and 865).
The exception is the first preference in the table: the deferral of the active income of controlled
foreign corporations (CFCs) under Section 11(b). It is the only tax provision from which U.S.based manufacturing firms derive significant benefits that encourages them to invest outside the
United States, especially in countries with lower tax rates than the United States. A CFC is a
11

U.S. Congress, Senate, Committee on the Budget, Tax Expenditures: Compendium of Background Material on
Individual Provisions, 111th Cong., 2d sess., S. Prt. 111-58 (Washington: GPO, December 2010), p. 3.

Congressional Research Service

8

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

foreign corporation in which U.S. shareholders own 50% or more of its total voting power or the
total value of its stock on any day of a tax year. The federal government taxes U.S.-chartered
corporations on their worldwide income. Section 11(b) permits U.S.-based corporations with
CFCs to postpone indefinitely U.S. taxation of their subsidiaries’ earnings while the earnings
remain in the control of the CFCs and are reinvested abroad. A U.S. parent corporation pays
federal tax on its subsidiaries’ earnings only when they are repatriated as intra-firm dividends or
certain other kinds of income. That tax is reduced by a U.S. credit for any income taxes the
subsidiaries paid to the host countries on the same earnings; the credit is intended to avoid the
double taxation of foreign-source income under the federal tax code. The option for deferral and
the availability of the foreign tax credit give U.S. firms an incentive to establish operations with
their own profit centers in countries with relatively low tax rates.
While any U.S.-chartered corporation with one or more CFCs can benefit from deferral, there is
evidence that corporations engaged primarily in manufacturing have been major beneficiaries. A
case in point is the corporate response to a temporary reduction in the U.S. tax rates for
repatriated earnings under the American Jobs Creation Act of 2004 (P.L. 108-357). The act
allowed U.S. corporations to take a one-time deduction equal to 85% of any increase in their
repatriated foreign-source income in either their first tax year beginning on or after the date of
enactment or their last tax year beginning before that date. For companies subject to a corporate
income tax rate of 35%, the deduction lowered the effective rate on the repatriated income to
5.25%. Credits for foreign taxes paid on the repatriated earnings were reduced by the same
amount. To claim the deduction, companies had to establish a domestic investment plan for the
repatriated funds. In addition, the deduction was limited to the greater of $500 million or the
amount of earnings shown on a firm’s books permanently invested outside the United States as of
June 30, 2003. According to the House and Senate conference report on the act, the temporary tax
reduction was intended to stimulate increased business investment and hiring and would not be
extended or enacted again anytime soon.12 In a 2008 report on the one-time dividends received
deduction, the Internal Revenue Service (IRS) noted that manufacturing corporations filed 55%
of the returns for the 2004 to 2006 tax years claiming the deduction and accounted for 81% of all
qualifying dividends.13 Nearly half of all qualifying dividends were repatriated by firms in the
pharmaceutical, electronic, and computer industries.

12

U.S. Congress, Conference Committee on the American Jobs Creation Act of 2004, conference report to accompany
H.R. 4520, H.Rept. 108-755, 108th Cong., 2nd sess. (Washington: GPO, 2004), p. 314.
13
Melissa Redmiles, The One-Time Received Dividend Deduction, Statistics of Income Bulletin, Washington, DC,
Spring 2008, available at http://www.irs.gov/pub/irs-soi/08codivdeductbul.pdf.

Congressional Research Service

9

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Table 2. Federal Tax Provisions That Provide Significant Benefits
to Manufacturing Firms

Tax Provision
Deferral of
active income of
controlled
foreign
corporations

Research and
experimentation
tax credit

Expensing of
research and
experimental
expenditures

Code
Section(s)
11(d)

41

174

Congressional Research Service

Current
Status
Permanent

Temporary:
expired at the
end of 2014

Permanent

Total
Estimated
Revenue Cost
for All Users in
FY2015
$82.1 billion

$4.7 billion
(There is no
estimate of the
revenue effects
of the credit for
FY2015 because
the credit
expired at the
end of 2014 and
has not been
extended. A bill
passed by the
House in May
2015 (H.R. 880)
would
permanently
extend and
simplify the
credit. An
estimated $4.7
billion in revenue
would be
forgone because
of the credit in
FY2105.)
$5.1 billion

Benefit to Manufacturing Firms
•

U.S.-based manufacturing corporations
account for a substantial share of the
accumulated earnings and profits held by
the foreign subsidiaries of U.S.
multinational corporations.

•

Provision allows U.S. parent companies
to defer U.S. tax on income earned and
reinvested by their foreign subsidiaries
until the income is repatriated as
dividends.

•

Provides an incentive to establish
subsidiaries in countries with corporate
tax rates lower than U.S. rates.

•

Provision allows firms a tax credit equal
to as much as 20% of qualified research
spending above a base amount.

•

As a result, it can lower after-tax cost of
qualified research, encouraging more
investment for that purpose.

•

Manufacturing accounted for 69% of the
total value of claims for the credit by
corporations in the 2008 and 2009 tax
years combined.

•

Provision allows firms to deduct
spending on qualified research as a
current expense, rather than as a capital
expense.

•

This treatment lowers the marginal
effective tax rate on returns to
investment in such research.

•

According to data published by the
National Science Foundation,

10

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Tax Provision

Code
Section(s)

Current
Status

Total
Estimated
Revenue Cost
for All Users in
FY2015

Benefit to Manufacturing Firms
manufacturing firms performed or
funded 64% of domestic basic and
applied research in 2007.

Depreciation of
equipment and
buildings
(excluding rental
housing) in
excess of the
alternative
depreciation
system (Section
167)

Deduction for
qualified
domestic
production
activities income

Partial exclusion
on gains from
the sale or
exchange of
qualified small
business stock

168 and
179

Section 168:
permanent

$32.6 billion

Section 179:
permanent,
though the
maximum
allowance and
phase-out
threshold can
vary from
year to year

199

1202

Congressional Research Service

Permanent

Permanent

$17.2 billion

$0.9 billion

•

Section 168 generally allows firms to
recover the cost of qualified assets
sooner than they can be recovered
under the alternative depreciation
system in section 167.

•

Section 179 makes it possible for firms
to expense a limited amount of the cost
of qualified assets placed in service in a
tax year.

•

Full (or 100%) expensing imposes a 0%
marginal effective tax rate on returns to
investment in affected assets.

•

Though data on investment by industry
in equipment and software are not
readily available, it is likely that
manufacturing firms account for a major
share of total investment in those
assets, especially equipment.

•

Provision allows firms to deduct 9% of
qualified domestic production activities
income; the deduction is 6% for
activities related to oil and gas
production; the deduction cannot
exceed a firm’s taxable income or 50%
of wages linked to those activities.

•

Qualified activities encompass
manufacturing, mining, film production,
energy, construction, engineering, and
architectural services.

•

Deduction lowers the top marginal tax
rate on income earned from
commercial use of favored property
from 35% to 31.85%.

•

In 2008, according to IRS data,
manufacturing accounted for 66% of the
total value of claims for the domestic
production activities deduction by
corporations.

•

Provision allows non-corporate
taxpayers to exclude from gross income
100% of any gain from the sale or
exchange of qualified small business
stock acquired after September 27,
2010, and before January 1, 2014; the
exclusion reverts to 50% for stock

11

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Tax Provision

Code
Section(s)

Current
Status

Total
Estimated
Revenue Cost
for All Users in
FY2015

Benefit to Manufacturing Firms
acquired on or after January 1, 2014.

Inventory
accounting: use
of the last-in,
first-out (LIFO)
method

Inventory
property sales
source rule
exception

472

861, 862,
863, and
865

Congressional Research Service

Permanent

Permanent

$1.8 billion

$3.0 billion

•

To qualify for this treatment, a taxpayer
must acquire the stock at original issue
and hold it for a minimum of five years.

•

Qualified small business stock must be
issued by a C corporation with no more
than $50 million in gross assets when
the stock is issued.

•

At least 80% of the assets must be used
in a qualified trade or business (including
manufacturing) during most of the
required five-year holding period.

•

Provision is intended to expand access
to equity capital by small start-up C
corporations that may otherwise have
trouble attracting such capital. Large
corporations do not benefit from the
exclusion.

•

Provision allows taxpayers that must
maintain inventory records in order to
account for the cost of goods sold to
exclude any increase in the value of
goods they buy or produce from taxable
income.

•

LIFO is most beneficial to firms facing
rising costs for the goods in their
inventories.

•

Research indicates that the vast share of
firms that use LIFO for tax purposes are
involved in manufacturing.

•

Provision enables taxpayers to reduce
the tax burden on the difference
between the sales price and cost of
inventories.

•

It also creates beneficial tax planning
opportunities that do not exist with the
first-in, first-out (or FIFO) method of
inventory accounting.

•

Provision allows U.S. exporters an
exception to the rule that income is
sourced according to the residence of
the seller.

•

Under the exception, inventory that is
bought and then re-sold is governed by
a rule known as the “title passage” rule.

•

The rule sources income from the sale
in the country where the sale occurs.

12

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Tax Provision

Code
Section(s)

Current
Status

Total
Estimated
Revenue Cost
for All Users in
FY2015

Benefit to Manufacturing Firms
•

Inventory that is made and sold by the
company is treated as having a divided
source: half of the income from a sale is
sourced in the United States and half in
the country where the sale occurs.

•

U.S. companies with excess foreign tax
credits may use them to reduce U.S.
taxes if they can shift income from U.S.
sources to foreign subsidiaries.

•

Companies with excess foreign tax
credits can take advantage of the
inventory sales source rule exception to
increase the amount of their credits that
can be applied against their U.S. income
tax liability. This has the same effect as
exempting from U.S. taxation the
income that was sourced in another
country as a result of the exception.

•

The source rule exception for inventory
sales probably raises the rate of return
from investing in exporting.

•

Manufacturers account for two-thirds of
U.S. exports of goods and services.

Source: Compiled by CRS from data provided in U.S. Congress, Joint Committee on Taxation, Estimates of
Federal Tax expenditures for Fiscal Years 2014-2018, JCX-97-14 (Washington: GPO, August 5, 2014).

Arguments For and Against Federal Support for
Manufacturing
The current debate over whether to expand federal support for manufacturing is reminiscent of
the lively (and at times acrimonious) debate over industrial policy that influenced the formulation
and implementation of U.S. economic policy in the 1980s. In both cases, a primary concern was
and is the short- and long-term economic consequences of a sustained decline in the domestic
manufacturing base driven largely by increasing foreign competition in key global markets,
particularly those for advanced technology products.
Proposals to enhance federal support for manufacturing raise a number of policy issues. One is
the economic rationale for such support. If such support can be justified on economic grounds,
then the case for retaining or enhancing existing support becomes harder to refute, dismiss, or
ignore.
The question of whether federal assistance for manufacturing is justified on economic grounds
also has noteworthy implications for the debate in the 114th Congress over reforming the federal
tax code. Several proposals to expand federal support for manufacturing have been introduced, a

Congressional Research Service

13

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

few of which include new or expanded targeted tax incentives.14 In effect, these incentives would
increase the after-tax rate of return on investments by manufacturing companies, relative to the
after-tax rate of return on investments by non-manufacturing companies, other things being equal.
While the relative rates of return on business investments is only one of the forces shaping the
domestic allocation of economic resources, it could divert to manufacturing businesses some of
the capital that otherwise would flow into non-manufacturing businesses. Such an outcome would
appear to run counter to some of the commonly held general aims of tax reform proponents.
These include a revenue-neutral simplification of the federal income tax through a reduction or
repeal of certain individual and business tax preferences in exchange for tax rate cuts, and the
elimination of tax preferences that distort the allocation of resources in the U.S. economy in ways
that hamper its growth. Current or proposed tax-based support for manufacturing raises the
question of how Congress could reconcile such support with those aims. Such a task may be
easier if there is an economic justification for targeted federal subsidies for manufacturing
industries.

Argument for Targeted Government Assistance for Manufacturing
Proponents of targeted government assistance for manufacturing offer several arguments to
justify it. The arguments are largely based on the sector’s current and historical contributions to
the U.S. economy. More specifically, they focus on the importance of manufactured products to
U.S. exports, the wages and benefits available in the manufacturing sector, the role of
manufacturing in technological innovation, the links between manufacturing and other sectors,
and actions taken by other countries to support manufacturing. Each is examined below.

Driver of Export Growth
The case for greater federal aid for manufacturing rests in part on a view held by a number of
economists that the United States would be better off relying less on consumption and imports
financed by foreign borrowing to grow its economy and relying more on domestic production of
goods and exports. Manufactured products (mainly chemicals, transportation equipment,
computers and other electronic products, and machinery) accounted for 49% of all U.S. exports
and 68% of all U.S imports in the first four months of 2015.15 Proponents of more federal support
for manufacturing maintain that these figures demonstrate that manufacturing has to play a
leading role in any credible plan for reducing the U.S. trade deficit. In their view, the federal
government should launch renewed efforts to dismantle the remaining barriers in key countries to
the export of U.S. manufactured products and persuade major exporting nations like China to
adopt more flexible exchange rate regimes. They also call for the adoption of federal initiatives to
bolster the competitiveness of U.S. manufacturers through subsidized investments in workforce
development, new production facilities, and R&D.

14

See H.R. 255, H.R. 1852, H.R. 2000, H.R. 2608, and S. 1054.
See U.S. Department of Commerce, Census Bureau and Bureau of Economic Analysis, U.S. International Trade in
Goods and Services: April 2015, press release, June 3, 2015, available at http://www.census.gov/foreign-trade/PressRelease/current_press_release/ft900.pdf.
15

Congressional Research Service

14

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Source of Relatively High Wages and Benefits
Proponents also point to the wages and benefits provided by manufacturing firms as another
reason why targeted government support for manufacturing industries is warranted. This is
because the compensation paid workers in manufacturing is larger, on average, than the labor
compensation provided in other non-agricultural industries (see Figure 1), though the gap has
been shrinking over time. Estimates of the size of the pay gap vary. For instance, between 2005
and 2010, according to data from the Bureau of Labor Statistics, average weekly earnings in
manufacturing were 21% greater than average weekly earnings in all private non-agricultural
industries. By contrast, according to a recent study by Mark Price of the Keystone Research
Center, manufacturing workers earned 8.4% more each week than non-manufacturing workers
from 2008 to 2010.16 There is evidence that this gap is even larger for manufacturing firms that
have relatively high ratios of exports to total production.17 Not all non-manufacturing industries
pay less than the average wage in manufacturing. But the ones that do pay more, according to
Price’s research findings, such as mining, utilities, telecommunications, finance, insurance,
professional and technical services, hospitals, and public administration, accounted for only 21%
of total non-manufacturing workers. Price also found that low-wage workers benefitted the most
from manufacturing jobs and high-wage workers benefitted the least, suggesting that
manufacturing has the potential to lower wage gaps among workers.
Moreover, proponents note that manufacturing jobs are more likely to provide fringe benefits than
non-manufacturing jobs, and that a higher share of manufacturing workers (48%) have no formal
education beyond a high-school diploma than non-manufacturing workers (37%) do.18
Consequently, say proponents, added federal support for manufacturing could open up more
middle-income job opportunities and lower income inequality within the domestic workforce.

Critical Source of New Commercial Technologies
Proponents cite the myriad links between manufacturing and technological innovation as yet
another reason why federal policy should offer special support for manufacturing firms.
According to data from the National Science Foundation (NSF), in 2012, manufacturing firms as
a whole performed 69% of the business R&D conducted in the United States and employed 60%
of the workers involved in domestic business R&D.19 Since technological innovation serves as
the principal engine of long-term growth in both productivity and the economy, proponents
maintain that the federal government should adopt policies that encourage manufacturers to
conduct more of their R&D in the United States. According to NSF data, U.S.-based
multinational manufacturing companies conducted an estimated 76% of their worldwide R&D in
16
Susan Helper, Timothy Krueger, and Howard Wial, Why Does Manufacturing Matter? Which Manufacturing
Matters? Metropolitan Policy Program, Brookings Institution, February 2012, p. 4.
17
A 2010 study by David Riker from the International Trade Administration at the U.S. Department of Commerce
found that workers in export-intensive manufacturing industries earned 18% more, on average, than workers in other
manufacturing industries from 2006 to 2008. See David Riker, Do Jobs In Export Industries Still Pay More? And
Why?, Manufacturing and Services Economics Brief, Department of Commerce, International Trade Administration,
July 2010, p. 5.
18
Ibid., p. 5.
19
Raymond M. Wolfe, Business R&D Performance in the United States Tops $300 Billion in 2012, National Science
Foundation, National Center for Science and Engineering Statistics, InfoBrief, NSF 15-303 (Arlington, VA: Oct. 2014),
Tables 2 and 3.

Congressional Research Service

15

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

the United States in 2011, the most recent year for which figures are available.20 But this share
may have declined since then, as some of these companies have transferred part of their R&D
operations to Asia to take advantage of markets with strong growth potential, plentiful supplies of
well-educated and well-trained researchers and engineers willing to work at salaries below
average U.S. salaries for comparable work, and generous government subsidies.

Major Player in the Development of Clean-Energy Technologies
Proponents say the manufacturing sector makes a “disproportionately large” contribution to the
development and production of goods and services with clear environmental benefits. A 2012
report by the Brookings Institution estimated that 26% of the 2.7 million jobs in the “clean
economy” are in the manufacturing sector, even though those jobs represented only 9% of
private-sector jobs.21 Proponents also note that numerous green technologies and products are
made by manufacturing firms, including electric vehicles, water-efficient products, energyefficient appliances, and environmentally friendly chemical products. In their view, these
contributions suggest that a competitive, growing manufacturing sector is needed to provide the
United States with the workforce skills, engineering talent, and innovative capabilities required to
meet the twin technological challenges of producing more clean energy and reducing the use of
energy derived from fossil fuels. Proponents argue that special federal assistance for domestic
development and production of new and advanced green technologies is critical to the
achievement of these goals.

Linkages to Other Industries
Backers of targeted government assistance for manufacturing industries also cite the role they
play in the growth of other industries as another justification for this assistance. This role has two
critical aspects.
One is the impact of manufacturing output on the collective output of other sectors, or what is
known as the multiplier effect of the demand for manufactured products. Proponents point out
that there is evidence that the manufacturing sector exerts a stronger pull on overall output than
any other sector. One measure of this pull is a sector’s backward linkage in the input-output
structure of an economy. This linkage refers to the impact on the output of supplying sectors such
as raw materials, services, construction, and energy of the level of output in another sector. As a
sector’s backward linkages expand, at least in the short run, its influence on overall output grows
as well. According to an analysis by the Manufacturing Institute of input-output data 2012 for all
sectors in 2012 from the U.S. Bureau of Economic Analysis, $1.00 of final demand for
manufactured products led to $1.33 in output from all other sectors combined. Agriculture,
forestry, hunting, and fishing: had the second largest backward linkage: $1.00 in final demand
resulted in $1.11 in output from all other sectors.22

20

National Science Foundation, National Center for Science and Engineering Statistics, Business Research and
Development Innovation: 2011, NSF 15-307 (Arlington, VA: 2014), Table 4.
21
Helper, Krueger, and Wial, Why Does Manufacturing Matter? p. 14.
22
Manufacturing Institute, Manufacturing’s Multiplier Effect is Stronger than Other Sectors, available at
http://www.themanufacturinginstitute.org/Research/Facts-About-Manufacturing/Economy-and-Jobs/Multiplier/
Multiplier.aspx.

Congressional Research Service

16

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

The second aspect concerns the contribution of manufacturing firms to the domestic climate for
industrial innovation in general, and to the growth and competitiveness of certain nonmanufacturing industries in particular. Proponents maintain that product innovations in
manufacturing have had a major impact on the growth prospects for firms that use those
innovations in a variety of non-manufacturing industries. A case in point is the productivity gains
and other benefits in industries that invest in information technologies. Furthermore, say
proponents, manufacturing creates and supports numerous well-paying jobs in product and
process engineering, design, operations and maintenance, transportation, testing, R&D, payroll,
accounting, and legal work. In their view, the loss of domestic manufacturing jobs and production
through offshoring and plant closures diminishes the domestic ability to innovate, stunting the
ability of the U.S. economy to generate new well-paying jobs in a range of sectors. Thus,
according to proponents, targeted government support (particularly in the form of private-public
partnerships focused on technology development) is needed to ensure that the United States
sustains and grows this ability through the creation of “industrial commons”, which are
geographically based hubs where complementary manufacturing, engineering, and R&D
activities coalesce to allow participating firms to develop new technologies and bring them to the
market.23

Other Developed Countries Support Manufacturing
Yet another argument made in support of federal policies to assist manufacturing is that other
countries do so, some with notable success.24 According to some proponents, the exemplar is
Germany. In their view, the federal government would achieve better results with its targeted
assistance for manufacturing if it were to emulate German policy toward manufacturing.
Compared to the United States, Germany has achieved superior outcomes in manufacturing in
recent years, as exemplified by higher wages, a slower rate of job loss, and large trade surpluses.
Some attribute these results in part to public policies that have fostered the emergence and growth
of German R&D networks. Among other things, these networks have aided the growth and
competitiveness of the manufacturing sector by supporting a system of continuous vocational
training tied to industry needs, promoting stable access to finance for small and mid-sized
German companies, and encouraging the rise of collaborative systems involving unions and
companies for making important decisions on issues not subject to collective bargaining.
Proponents of greater federal support for manufacturing point to the German example as proof
that public policy can address the basic challenges facing the manufacturing sector in ways that
help a country accomplish key policy objectives such as relatively high wages, increased
technological innovation, larger trade surpluses, improved environmental protection, and greater
energy conservation.25

23
Michael Ettinger and Kate Gordon, The Importance and Promise of American Manufacturing, Center for American
Progress (Washington: Apr. 2011), p. 5; and Massachusetts Institute of Technology, A Preview of the MIT Production
in the Innovation Economy Report (Cambridge, MA: Feb. 22, 2013), pp. 27-29.
24
For an assessment of the support for manufacturing offered by Australia, Canada, Germany, Japan, Spain, and the
United Kingdom, see Information Technology & Innovation Foundation, International Benchmarking of Countries’
Policies and Programs Supporting SME Manufacturers (Washington: September 2011). Available at
http://www.itif.org/publications/international-benchmarking-countries%E2%80%99-policies-and-programs-supportingsme-manufacturer.
25
Helper, Krueger, and Wial, Why Manufacturing Matters, p.28.

Congressional Research Service

17

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

A 2013 report by the Government Accountability Office (GAO) examined the support for the
manufacturing sector offered by the national governments in Germany, as well as three other
developed countries: South Korea, Japan, and Canada.26 The report found that these countries
provided a varied mix of programs to support manufacturing industries; it also found that there
were some significant differences between those efforts and the support provided by the federal
government. A common thread in all the programs (including those of the United States) was an
emphasis on targeted support for innovation among small- and medium-sized manufacturing
firms (SMFs).
South Korea supported its manufacturers through funding for a variety of national research
institutes (including one focused on telecommunications and information technology), clean
energy technology development, and a national network of “technoparks,” which operated as
regional innovation centers where companies (especially SMFs) could collaborate with
researchers from the national research institutes and universities and local governments in the
commercial development of new technologies.
The Japanese government took a number of steps from 2007 to 2012 to foster the formation and
growth of SMFs, mainly through the creation of collaborative research centers involving larger
businesses, universities, industry associations, financial institutions, research institutes, and
government agencies. These steps included the adoption of the following initiatives: Innovation
25 in 2007; Industrial Cluster Project in 2011; and Rebirth of Japan strategies in 2011 and 2012.
Among the efforts tied to the Rebirth of Japan strategies were increased public and private
investment in alternative energy R&D projects such as clean-energy motor vehicles and improved
battery performance for electric cars, and increased government support for technological
innovation by SMFs through the creation of a national network of Public Industrial Technology
Research Institutes.
And as of 2012, Canada relied on several initiatives to foster the growth of SMFs seeking to
develop and commercialize new products and processes. One was the Canadian Innovation
Commercialization Program, which helped SMFs take advantage of government procurement
programs for leading-edge products, services, and technologies. A second initiative was the
Industrial Research Assistance Program, which consisted of a national network of technical
advisors who worked directly with SMFs to promote the commercialization of their new goods
and services. Canadian manufactures also benefited from a tax credit for qualified investment in
R&D (known as the Scientific and Experimental Development tax credit) and a governmentfunded program (known as the Venture Capital Action Plan) to encourage private investment in
startup firms and to facilitate the creation of private venture capital funds.

Intended Recipients of Government Support
Proponents seem divided on the question of which firms should be eligible for government
assistance for manufacturing. This is a significant issue for public policy because the sector
consists of firms of different sizes and geographic reach in a range of industries that vary
considerably in the products they make and the markets they serve. Under the NAICS,
manufacturing embraces products as basic as bottled water and as sophisticated as
nanotechnology. Some proponents argue that federal policy toward manufacturing should take
26

U.S. Government Accountability Office, Global Manufacturing: Foreign Government Programs Differ in Some Key
Respects from Those in the united States, GAO-13-365 (Washington: July 2013).

Congressional Research Service

18

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

into account differences in financial condition and external economic benefits among industries
involved in goods production in deciding which firms, technologies, or industries to support.
Such an approach, in their view, would provide lawmakers with a clearer picture of the need for
policies to encourage the migration of workers from declining to growing industries, remedy
market failures that permit relatively inefficient firms to remain in business, and help small and
medium firms to raise their productivity.27 To assist manufacturing firms that are unlikely to
improve their competitiveness, say proponents, would be a waste of taxpayer money. Others
contend that the federal policy should target its assistance to bolster the “ability of enterprises to
develop and manufacture high-technology products in America.”28
Some call for a shift in government policy toward manufacturing so that special assistance is
directed to small companies only. In their view, such a focus makes sense for two reasons. First,
proponents of this limited approach point to evidence that young startup firms serve as “key
drivers of employment and technology growth” but lag behind large firms in adopting “new
technologies that would make them more productive.”29 Second, they argue that small and
medium firms face special difficulties in gaining needed public information and advisory
services, but that they play “critical roles” in supporting the competitiveness of large U.S.
manufacturers.

Arguments against Targeted Government Assistance for
Manufacturing
In spite of what appears to be a bipartisan consensus in favor of greater federal support for
manufacturing, not everyone agrees that such assistance is warranted on economic grounds.
Critics offer several reasons for their opposition to targeted government support for
manufacturing. They can be summarized as follows: (1) the lack of any market failures linked to
the performance of the manufacturing sector, (2) a sustained decease in the contributions of the
manufacturing sector to job creation and GDP over the past 50 years, and (3) the untapped
potential for growth in U.S. exports of services in which the United States may have a
comparative advantage. Additional details on each are given below.

Absence of Any Market Failure
Critics say the main reason why government assistance for manufacturing cannot be justified on
economic grounds is that the performance of the sector is not distorted by a market failure.
In general, a market failure is a condition or set of circumstances that prevents or hampers the
emergence of an efficient allocation of resources within a particular market, such as the market
for health insurance or passenger cars. Most economists would agree that when markets fail to
generate efficient outcomes, government intervention is required to remedy the problem. For
instance, if competition in a market is dominated by a few companies, antitrust laws can be used
to lessen the welfare losses by curtailing the sellers’ market power. The primary market failures
27

Ibid., p. 15.
Gary P. Pisano and Willy C. Shih, “ Restoring American Competitiveness,” Harvard Business Review, July-August
2009, p. 114.
29
Stephen Ezell, “Revitalizing U.S. Manufacturing,” Issues in Science and Technology, Winter 2012, available at
http://www.issues.org/28.2/ezell.html.
28

Congressional Research Service

19

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

involve public goods, externalities (positive and negative), a lack of competition, the absence of a
market, incomplete and asymmetric information, and the principal-agent dilemma.30
This basic principle of economic analysis implies that government support for an industry is
warranted only if a market failure is producing inefficient resource allocations within the industry.
An example of such a distortion is sub-optimal investment in R&D or capital assets like buildings
and equipment. Some say that manufacturing is prone to market failures resulting from three
activities that are characteristic of manufacturing: R&D investment, clustering of firms in the
same geographic area, and the process of learning by doing. But critics disagree with this
assessment on the grounds that there is no clear evidence that these activities engender market
failures that are unique to manufacturing.
One market failure some associate with manufacturing is inefficient levels of R&D investment.
This linkage is not surprising, since the sector accounts for over two-thirds of the domestic R&D
performed by companies, and companies are thought to invest too little in R&D because of their
inability to capture all the returns from those investments.31 The returns captured by entities other
than the innovator (i.e., other companies and consumers) represent the positive externalities or
spillovers from R&D investments. Though there is reason to believe that manufacturing is
affected by this market failure more than other sectors, the problem is bound to arise in any sector
where companies invest in R&D. Numerous non-manufacturing firms, such as those involved in
software development and Internet access (e.g., Microsoft and Google), invest substantial
amounts in R&D and thus may be as likely as any manufacturing firm to underinvest in R&D
relative to its overall social benefits.
In the view of critics, the appropriate policy response to the positive externalities associated with
R&D investment is to offer a subsidy intended to boost such investment that is available to
companies in all lines of business. Current federal policy does this by funding research that most
companies are loath or unwilling to undertake on their own (mainly basic research) and by
providing tax subsidies for private-sector spending on qualified research.
Some have argued that manufacturing is particularly vulnerable to a market failure associated
with industry clustering. This clustering occurs when a number of businesses from the same
industry set up shop in the same location. There is evidence that clusters of manufacturing firms
can be more productive and innovative than similar firms operating in isolation from one another.
As a result, when a company builds a plant in an area where a clustering exists, some of the
returns on that investment may accrue to other firms in the cluster. Leakages like this are identical
in effect to the positive externalities from R&D investments. Without a government subsidy,
companies would invest too little in joining clusters, relative to their economic benefits. But
critics say that the studies that have been done on the economic benefits of clustering have yet to
find evidence of such effects on a large scale.32 They also point out that the external benefits from
30
For more on market failures, see Joseph E. Stiglitz, Economics of the Public Sector, 3rd ed. (New York: WW. Norton
& Company, 2000), pp. 76-90.
31
This inability relates to the gap between the social and private returns to R&D investments. Research aimed at
measuring the returns on such investments indicates that the rate of return on such investments to the companies
making the investments is ¼ to ½ of the social rate of return, on average. This difference represents returns that benefit
consumers and companies other than the ones investing in R&D. It also denotes the extent of underinvestment in R&D
by the private sector. For more details, see Charles I. Jones and John C. Williams, Measuring the Social Return to
R&D, February 1997, available at http://www.federalreserve.gov/pubs/feds/1997/199712/199712pap.pdf.
32
Christina D. Romer, “Do Manufacturers Need Special Treatment,” The New York Times, February 4, 2012.

Congressional Research Service

20

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

clustering should arise in not only in manufacturing but in any industry where clustering occurs
on a significant scale, such as software, insurance, and entertainment.
Critics also cite “learning by doing” as another example of an alleged market failure in
manufacturing that has little or no merit. They note there is no evidence that the process, which
encompasses the time, analysis, and adjustments required to make a new production process work
efficiently, prevents companies developing new production methods from capturing the returns
from those investments. If this were not the case, then one could argue that government assistance
would be needed to ensure that firms invest in process innovations in optimal or near-optimal
amounts. But such is not the case, say critics. To substantiate this point, they cite a recent study of
the U.S. semiconductor industry that found that, while learning by doing represented a substantial
share of the cost of investing in new production methods, most of the rewards went to the
companies making the initial investments.33
Not even the external benefits associated with national defense spending justify targeted
government assistance for manufacturers, in the view of critics. They contend that not all
manufacturing firms are equally affected by a war effort. Moreover, according to critics, there is
no reason to believe that the existing U.S. production base for defense goods, supplemented by
military supply arrangements with allies, would be incapable of providing adequate supplies of
weapons and other needed materials during a war.34

Shrinking Source of Job Creation
A second argument against special assistance for manufacturing concerns job creation. Some
critics say it would be misguided in light of recent history for the federal government to target
assistance at manufacturing in the expectation that doing so would be likely to spark large
employment gains over time. Domestic employment in the sector has been gradually shrinking
(with a few temporary upturns) since 1979 and now accounts for almost 9% of U.S. non-farm
employment.35 In the view of critics, many of the factory jobs that were lost over the past three
decades are not coming back. They cite several reasons why a return of such jobs on a massive
scale is unlikely. First, many of the jobs involved skills that were readily available in places like
China and Mexico. Second, even if every U.S. multinational company were to stop outsourcing
production and no imports of manufactured products were allowed in the United States, domestic
manufacturing employment would probably continue to fall relative to other sectors. This is
because Americans have been spending less of their disposable income on goods and more on
services since the late 1970s, a trend that is unlikely to change anytime soon. Service industries
now account for 44% of U.S. non-farm payroll jobs. Critics also note that the main cause of the
mostly sluggish U.S. job growth since the end of the Great Recession in June 2009 has been a
slow recovery in aggregate demand here and in other major countries. Thus, in their view,
increasing assistance to manufacturing firms, especially SMFs, would do little to boost job
creation in the short run, since the assistance would have virtually no effect on the overall
demand for goods and services made in the United States.

33

Ibid.
Ibid.
35
In April 2015, according to payroll employment figures released by the U.S. Bureau of Labor Statistics,
manufacturing firms accounted for 8.7% of U.S. non-agricultural employment. See http://www.bls.gov/web/empsit/
ceseeb1a.htm.
34

Congressional Research Service

21

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

Promoting Service Exports Would Do More to Stimulate the Economy
Critics also say the U.S. economy would benefit more in the short run from government efforts to
dismantle foreign barriers to U.S. exports of services than from new programs to bolster the
competitiveness of U.S. manufacturers, especially SMFs. They say the United States has a larger
comparative advantage in highly skilled services such as engineering, law, finance, and
architecture than it does in products made with the use of low-skilled workers (e.g., apparel,
wood products, processed foods). In addition, critics note that although the United States is the
leading exporter of services in the world,36 there is considerable untapped potential for expanding
U.S. service exports. Current exports come from a small percentage of U.S. companies, and there
has been an upsurge in infrastructure development in faster-growing economies like China, India,
and Brazil in the past decade. According to an estimate by economist J. Bradford Jensen, the
United States could more than double its service exports if existing foreign barriers were
removed, creating an additional $800 billion in tradable business services like law and
engineering.37 Such an increase would support or create nearly three million U.S. jobs, according
to Jensen, and those jobs would be likely to pay higher wages than manufacturing jobs, on
average. In light of such possible gains, critics argue that the federal government should focus
more on pressing other governments to open up their service markets to U.S. companies than on
promoting exports by domestic manufacturers with no foreign subsidiaries.

Implications of the Arguments for Federal Policy
toward Manufacturing
The debate over whether manufacturing industries should receive federal assistance raises several
issues that Congress may wish to take into consideration as it examines options for reforming the
federal income tax or laying a foundation for future robust economic growth. Each issue has
implications for federal policy toward manufacturing.
The evidence cited by both sides in the debate to support their arguments suggests there is no
clear economic rationale for providing federal support for the manufacturing sector as a whole.
Goods production as an economic activity seems free of any obvious market failures. Some
proponents point to manufacturing’s major contributions to technological innovation and the
positive external benefits associated with R&D investment as evidence that the sector is subject to
a market failure. But such an argument is difficult to reconcile with the fact that the positive
externalities associated with R&D are not limited to manufacturing but extend, at least in theory,
to all companies that invest in R&D. Federal tax policy has recognized this economic reality for
nearly 60 years. In 1954, Congress passed a sweeping revision of the federal tax code that
included a permanent expensing allowance for qualified research expenditures. In 1981, Congress
added a temporary research tax credit to the tax code. Both provisions remain in effect, though
the credit has been modified significantly several times and extended 16 times. Since eligibility
for these tax subsidies depends critically on the nature of the research a firm finances and the
nature of its research expenditures, and not on the industry in which a firm is classified, the

36

According to the latest figures on commercial service exports from the International Monetary Fund, U.S. exports of
services in 2013 totaled $662.9 billion, or 14% of the worldwide amount. The second largest exporter of services was
Germany, which accounted for 7% of world exports..
37
Catherine Rampell, “Some Urge U.S. to Focus on Selling Its Skills Overseas,” The New York Times, April 10, 2012.

Congressional Research Service

22

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

subsidies have the potential to stimulate increased investment in innovative activity across all
sectors, not just in manufacturing.
The debate also suggests that increased federal aid for manufacturing on the whole would be
unlikely to spark a significant rise in the domestic rate of job creation. The sector’s contribution
to overall employment has been declining for more than three decades and now stands at just
under 9% of U.S. non-farm employment. In an economy marked by uneven and relatively weak
job growth more than six years after the end of the 2007-09 recession, it can be argued that
increased federal assistance for manufacturing would do less to spur faster job growth in the short
run than policy measures that deliver a greater stimulus to aggregate demand, such as increased
federal spending on the rebuilding and expansion of the U.S. transportation network.
Another issue raised by the arguments for and against targeted federal support for manufacturing
concerns the importance for the domestic climate for technological innovation of the undertaking
of production and R&D in the same location. Proponents of a greater federal role in revitalizing
the domestic manufacturing base say that the future growth potential of the U.S. economy hinges
in part on finding ways to convince more manufacturing firms to perform a substantial share of
their R&D and production in the United States. A critical consideration here is the impact on the
competitiveness of companies that invest heavily in R&D of separating innovation activities and
production in different countries (or perhaps in different companies). Proponents contend that
such a separation makes it harder for a company to take full advantage of the commercial benefits
from implementing new technologies. But the evidence is not conclusive either way. Thus,
Congress may want to look into the extent to which the economic returns from innovation depend
on domestic production capabilities tied to the domestic development of new products and
processes.
The debate also leaves the distinct impression that policy initiatives to bolster the international
competitiveness of U.S. manufacturers would have similar benefits for other sectors, and thus
should not be limited to manufacturing. Some proponents of a greater federal assistance for
manufacturing say federal policy should focus on four objectives: increased R&D support, greater
investment in worker training, improved access to investment capital, and the creation of new
collaborative mechanisms for creating and sharing productivity improvements and other
innovations among smaller firms. Yet there is no obvious reason why most firms in other
industries would not benefit from them as well. Rather than focusing on manufacturing as the
primary pathway to growing the U.S. economy, Congress might consider policy options for
providing more R&D support, improving worker training to reduce mismatches between
employer skill needs and the skill sets of workers, expanding access to credit for small- and
medium-sized companies, and encouraging the growth of industry-specific networks that could
offer a range of collaborative services for the mutual benefit of individual firms that would apply
to all industries.
Finally, though this issue is not the primary focus of the arguments addressed here, Congress may
wish to examine the advantages and disadvantages of using tax incentives as a primary tool for
achieving any policy objectives it may establish for manufacturing industries. Permanent tax
incentives require no annual appropriations or other congressional action to have their intended
effect. They operate like hidden entitlements that can produce sizable revenue losses, impose
significant compliance burdens on companies, and generate additional enforcement costs for the
IRS. By contrast, policy initiatives based on spending can be more transparent and amenable to
congressional oversight. The comparative advantages of spending programs (including credit
guarantees) and of tax incentives aimed at a specific industry like manufacturing might receive

Congressional Research Service

23

Federal Tax Benefits for Manufacturing: Current Law and Arguments For and Against

greater scrutiny as Congress considers options for tax reform in the coming months. Some
options would seek to achieve revenue neutrality by lowering business income tax rates and
expanding the business tax base by reducing or repealing certain business tax incentives.

Author Contact Information
(name redacted)
Analyst in Public Finance
/redacted/@crs.loc.gov, 7-....

Congressional Research Service

24

EveryCRSReport.com
The Congressional Research Service (CRS) is a federal legislative branch agency, housed inside the
Library of Congress, charged with providing the United States Congress non-partisan advice on
issues that may come before Congress.
EveryCRSReport.com republishes CRS reports that are available to all Congressional staff. The
reports are not classified, and Members of Congress routinely make individual reports available to
the public.
Prior to our republication, we redacted names, phone numbers and email addresses of analysts
who produced the reports. We also added this page to the report. We have not intentionally made
any other changes to any report published on EveryCRSReport.com.
CRS reports, as a work of the United States government, are not subject to copyright protection in
the United States. Any CRS report may be reproduced and distributed in its entirety without
permission from CRS. However, as a CRS report may include copyrighted images or material from a
third party, you may need to obtain permission of the copyright holder if you wish to copy or
otherwise use copyrighted material.
Information in a CRS report should not be relied upon for purposes other than public
understanding of information that has been provided by CRS to members of Congress in
connection with CRS' institutional role.
EveryCRSReport.com is not a government website and is not affiliated with CRS. We do not claim
copyright on any CRS report we have republished.

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/crs%3AR42742. Public record. Not legal advice.