David Cay Johnston

If President Barack Obama can persuade Congress to reduce the corporate income tax rate to 28 percent from 35 percent, he will move tax rates closer to what other modern countries charge.

But his plan to treat “manufacturing” as a special category, with a 25 percent tax rate, brings us to what I call Obama’s hamburger problem.

The problem is how to define manufacturing. To paraphrase Justice Potter Stewart on obscenity, I know manufacturing when I see it; I just don’t know how to define it in tax law.

Assembling automobiles is considered manufacturing. So what about assembling two hot protein discs with special sauce, lettuce, cheese, pickles, onions — all on a sesame seed bun?

The notion of hamburger-making as manufacturing may seem silly, a bit like the 1981 U.S. Agriculture Departmentproposal to classify ketchup as a vegetable for school lunches. But classifying activities as manufacturing or not becomes crucial if manufacturers pay taxes at a reduced rate.

Imagine all the high-paying jobs Obama’s plan would create. Companies of all kinds will want to hire more tax accountants and lawyers making the case their client’s business activity is manufacturing. These are not the sort of additional jobs America needs.

There could also be more work for economists, engineers and historians whose expertise would be tapped for creative ways to expand the definition of manufacturing. We have the prototype for the reduced manufacturer’s tax rate in the Domestic Production Activities Deduction, a law implemented in 2005 which comes with a plethora of complex eligibility rules that already create more work for tax professionals.

DRAG ON ECONOMY

Scrutinizing tax returns to determine what is and is not manufacturing would further require a diversion of IRS auditors, lawyers and specialists from the more important job of hunting for calculated tax evaders. Inevitably there would be litigation aplenty, a boon to trial lawyers but a drag on the economy.

Building an automobile obviously involves manufacturing. Rocks must be refined to turn their useful elements into steel and aluminum. Much of the added value will be in the engine and transmission, where steels made with special alloys must be heat-treated and machined to endure enormous, and rapid, twisting forces. Increasingly cars are built with plastics, sophisticated chemical compounds that must be created from base materials and then molded or extruded.

But should mere assembly of an automobile qualify as manufacturing? Does fitting the already manufactured pieces together qualify as manufacturing? And what if the parts were all manufactured in, say, Japan while the only activity in the United States was assembling them into a whole?

Would tax law define manufacturing as the process of making a car as a whole? Or would companies lobby for laws that break it into parts with profits earned at different stages of production taxed at different rates? Would that, in turn, mean accounting practices that load costs onto one stage of production to take profits at the 25 percent rate and losses, such as an assembly line, at the 28 percent rate?

Imagine a car company that reports a $200 million profit to shareholders. Now imagine that it reports a $300 million manufacturing profit taxed at 25 percent and a $100 million assembly line loss at the 28 percent general corporate rate. The company’s profit would still be $200 million, but its blended tax rate would be just 23.5 percent.

Hamburgers may seem like pure assembly, but a case can be made that they are more like manufacturing than assembling a car from finished parts made overseas.

Your local hamburger joint starts with raw meat, fresh or frozen. If it comes in lumps then someone must make the meat into uniform discs or squares. Then the protein must be fried, grilled or broiled. Only then can the meat, lettuce and whatnot be assembled.

Eight years ago the Bush administration used this very example to warn about the unintended consequences of tax incentives for manufacturing.

The 2004 Economic Report of the President asked, “when a fast-food restaurant sells a hamburger, for example, is it providing a ‘service’ or is it combining inputs to ‘manufacture’ a product?”

The comment, put in a box on its own page to draw attention to the issue, also noted that “sometimes, seemingly subtle differences can determine whether an industry is classified as manufacturing. For example, mixing water and concentrate to produce soft drinks is classified as manufacturing. However, if that activity is performed at a snack bar, it is considered a service.”

Taxing different corporate activities at different rates is a bad idea unless you think we need more national income spent on gaming the tax system. Let’s not go there.

PHOTO: Russia’s President Dmitry Medvedev (2nd  L) and U.S. President Barack Obama (R) eat their hamburgers during lunch at Ray’s Hell Burger in Arlington, Virginia, June 24, 2010.     REUTERS/Kevin Lamarque

By David Cay Johnston

The author is a Reuters columnist. The opinions expressed are his own.

The Washington debate over whether to voluntarily default on the U.S. government’s obligations revealed a serious political ailment in Congress: mass economic amnesia.

Just 11 years ago, Republicans insisted budget surpluses were bad for the economy, while Democrats told us surpluses would make the economy flourish. Al Gore said pay off the federal debt; George W. Bush said cut taxes so people would have more money.

During the Bush years Democrats decried the red-ink budgets, while Republicans assured us that no real harm would come from a $5 trillion borrow-and-spend spree.

Yet last weekend it was the other way around. The Democrats described a few more years of deficit spending as vital to making up for massive loss of jobs, while Republicans warned that any more red ink would destroy America as we know it. Feeling confused? You should be. And maybe, like the Beijing government, you see the checks-and-balances the framers of the U.S. Constitution put in place to provide sound government replaced by farce.

There is a cure for bad political posture. Just dose yourself with the best elixir ever for manufactured crisis: facts. The posturing in Congress having stretched any sense of reality beyond recognition, here are 10 facts that would have informed the debate on Capitol Hill and can certainly inform your understanding of the federal fiscal follies:

COUNT TO 10
1. No sovereign government with monopoly control of its currency can go broke in its own currency. Since the Constitution gives Congress a currency monopoly it is axiomatic that talk of our government going broke is nonsense unless we have a revolution, in which case federal bonds won’t be worth the electrons used to keep digital track of them.

2. Gross federal debt today is up 250 percent from when President Bill Clinton left office, and up 35 percent from when President George W. Bush left office, but the government’s blended average interest rate has fallen 54 percent since Clinton and 22 percent since Bush, suggesting that the bond rating agencies’ warnings about the chances that federal debt will be serviced as promised are as reliable as their estimates of the likelihood that all those mortgage bonds would be Triple A investments.

3. Had America stuck by the tax-and-restrained-spending policies of President Clinton, and his budget projections proved reliable, the government today would have no debt. Instead it would have a surplus of $2.1 trillion, or nearly $7,000 per American.

4. President Obama’s first budget, for fiscal 2010, that began on Oct. 1, 2009, had a smaller deficit than President Bush’s last budget, which promised a $407 billion shortfall, missing the mark by only a trillion dollars.

5. Those Wall Streeters President Bush bailed out in his final days continue with their risky bets because, being too big to fail, they sense Washington is ready to bail them out by swapping their red ink for government black ink, a belief reinforced with campaign contributions to make sure the government spends little on banking regulators.

BOTH POLITICAL PARTIES
6. President Obama’s original budget ended a host of Bush-era devices that understated budget deficits, while at the same time laying out a plan to cut the deficit he inherited by half, partly by raising taxes on the top two percent of earners, but the Republicans most worried about red ink worried even more about taxing billionaires too much.

7. Federal budget deficits as far as the eye can see would be significantly smaller but for Obama acquiescing to Republican demands to extend the temporary Bush tax cuts for all and Democrats, who also rely on rich donors, meekly going along with it.

8. Federal individual income tax revenues in 2010 were smaller than in 2001, the recession year when the Bush tax cuts began. Revenue was down by $330 billion or 27 percent. Because America’s population keeps growing, income taxes per capita fell 32 percent from $4,310 per American to $2,910, making it harder still to balance the budget.

9. Healthcare costs rose just 3.9 percent in 2010, the smallest annual increase in modern times, according to the federal Center for Medicare & Medicaid Services actuary, while by 2020 the Affordable Care Act (what critics call Obamacare) will add just a tenth of one percentage point to healthcare costs while adding 30 million more Americans to health insurance rolls.

10. The deal to avoid voluntary default calls for squeezing Medicare and Medicaid spending even more while making sure the richest among us enjoy lower tax rates than the middle class do. A result will be more luxuries at the top, while pushing 40 percent of hospitals toward bankruptcy, though not until 2050 when about 40 percent of Americans living now will be beyond any benefit from hospital care.

Both political parties contributed to our federal debt. Manufactured crises like the debt ceiling vote mask the real issue, which is our desperate need for prudent policies that create broad prosperity by taxing, spending and managing debt for the good of country, not party.  (Editing by Howard Goller)