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Killing Two Birds With One Stone: Why Congress Should Establish a Tax Incentive For Companies Reshoring Production from China to U.S. Labor Surplus Areas

Killing Two Birds With One Stone: Why Congress Should Establish a Tax Incentive For Companies Reshoring Production from China to U.S. Labor Surplus Areas

March 7, 2021

U.S. trade scholars and government policymakers have come to the realization that the wave of globalization in the 2000s and 2010s did not work out for American workers as it should have. Secretary of State Tony Blinken reflected this view when he recently stated:

Some of us previously argued for free trade agreements because we believed Americans would broadly share in the economic gains. But we didn't do enough to understand who would be negatively affected and what would be needed to adequately offset their pain. Our approach now will be different.

At the same time, most trade scholars and policymakers have come to realize that China is a technology juggernaut, with the Communist Party aiming to achieve global dominance in most advanced industries and technologies, with severe possible threats to U.S. jobs, competitiveness, and national security.

This double-edged challenge also poses a double-edged opportunity: Congress can “kill two birds with one stone” by passing a time-limited tax incentive for firms that move Chinese production to U.S. Labor Department–designated “labor surplus areas.”

Doing this will accomplish two important goals. First, it will weaken China’s economic and technological capabilities by reducing production there, and it will strengthen U.S. capabilities by increasing domestic production, including making U.S. supply chains more secure.

This is precisely why Japan and Taiwan both enacted a program whereby their firms are eligible for grants to move production from China back to those two nations, respectively. Japan, for example, appropriated the equivalent of $2.2 billion and at least 87 companies moved production from China to Japan.

Second, by targeting high-unemployment areas, a reshoring incentive can help not only unemployed Americans, but also economically distressed and disadvantaged cities and counties across the nation. By law, the Labor Department must issue an annual list of labor surplus areas. These are U.S. counties or cities where the unemployment rate is 20 percent above the national average for a two-year reference rate, with the floor unemployment rate being 6 percent. In the most recent year, 431 counties and cities in most states qualified.

Some will argue it is not possible to reshore production, even with a financial incentive. But according to the Reshoring Initiative, which tracks reshoring announcements, between 2010 and 2019 a cumulative total of more than 900,000 jobs have been announced as reshored, although not all from China. Moreover, even with higher U.S. labor costs, improving automation technology can help lower the U.S.-China cost gap. In addition, labor costs will be lower in labor surplus areas than in large, expensive U.S. metropolitan areas.

A key challenge in designing a reshoring incentive is that it’s not clear how large the incentive should be. If it is too low, the incentive will have little effect. If it’s too high, more will be spent than necessary.

One way to address this is for Congress to establish a reverse auction tax credit based on the amount of value-added production located to a qualified labor market area. For example, if a company bids that it will move $50 million of annual value-added production (value added is the value of sales subtracted by input costs, such as electricity and supplier parts) back to the United States from China if it receives a tax credit of $20 million (40 percent of value added), and another company says it will move back $70 million for a $25 million credit (35 percent of value), the latter company would receive priority for credit funds because it asking for less subsidy per dollar of value-added than the first company.

There would be a one-time auction and all the bids would be accepted in reverse order of the subsidy share they ask for until all the appropriated funds are expended. To qualify, companies would have to close a Chinese facility and open one making the same product in a U.S. labor surplus area.

The reason to base this credit on value-added and not on jobs is because using the latter criteria would give an advantage to companies producing lower value-added products, which are usually in less technologically advanced sectors. America’s challenge vis-à-vis China is in advanced industries, where productivity and wages are higher. Moreover, using jobs as the factor would provide disincentives for companies to use advanced technology and invest in workforce training to be more productive.

It is not clear how large such a program should be. To equal Japan’s as a share of GDP, Congress would need to appropriate around $8 billion. But it is also not clear what level of interest there is in reshoring to the United States, even with an incentive, so to err on the side of caution and to ensure that reverse auction bids would be close to what companies actually need to make reshoring investments economically viable, Congress might cut that amount in half to $4 billion.

Given that the hoped-for Coronavirus relief package could be as high as $1.9 trillion, $4 billion would amount to about 2 percent. Given the benefits to U.S. competitiveness vis-à-vis China, job creation, and economic development in distressed regionss, that is small price to pay.

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