A Tax-Based Industrial Policy to Compete With China

The United States is losing the techno-economic war with China. And how could we not, when we face an adversary that engages in massive intellectual property theft, deploys industrial subsidies that dwarf anything Washington offers, and maintains closed domestic markets, all while at home in the U.S. there is virtually no serious analytical or policy work being done to support our advanced industries as a whole.

The best the Trump tariffs will do is help a few American companies gain some domestic market share. But the likely end result will be a significant decline in global market share for most U.S. advanced technology firms, as their foreign competitors enjoy access to global markets now denied to them.

There was a wave of enthusiasm during the Biden administration about how the United States had finally embraced industrial policy. But this was mostly hype. These efforts paled in comparison to bipartisan push from the mid-1980s to the early 1990s in response to the Japan-Germany challenge. Moreover, virtually all of the Biden era spending focused on green energy, not winning the techno-economic war against China. The CHIPS Act passed largely due to national defense concerns, while the “science” portion was essentially funding for university researchers to continue doing what they’ve long done: produce academic studies and publish journal articles. On top of that, Biden administration officials injected DEI and other social policy goals into the programs, justifying it by claiming that “they won the election.”

Now, we have a president and Congress that mostly rejects spending-based industrial policy: Trump sees tariffs as the “Swiss Army Knife” of U.S. international economic policy, and the Republican-controlled Congress wants to cut spending and views industrial policy as “picking winners.”

So, for those of us who view the China threat as the defining challenge facing the Republic and the West, we could simply wait four years and hope that a Democratic president will adopt the kind of proactive industrial strategy the nation needs. But the odds are slim. Given how far left the party has drifted, it’s far quite small. If a Democrat is in the White House in 2029, it is far more likely that a Democrat in the White House in 2029 would repeat the pattern of the last four years: lots of spending on “green equity.”

So, is there any alternative to long, slow decline like the one the United Kingdom continues to painfully endure? Let me suggest one: a tax-based industrial policy.

The goal of industrial policy is to align business activity with national interest. In this case, the behaviors the nation should encourage are fairly straightforward: more exports, more domestic investment, more research and development, more workforce training, and more involvement in global standards-setting. So, why not use the tax code to reward companies that pursue these activities in America?

Republicans might support it because it’s not heavy-handed. It doesn’t target specific firms or technologies, and it cuts taxes. Democrats might like it, or at least accept it, because it is likely to boost manufacturing and worker incomes.

So, here are four actions Congress should take:

1. Double the R&D and alternative simplified credits: Increase the regular credit from 20 percent to 40 percent, and the Alternative Simplified Credit (ASC) from 14 percent to 28 percent (while reinstating first-year expensing of R&D expenditures). Additionally, introduce a 40 percent ASC credit for business support of university or federal lab research.
2. Institute a 25 percent investment tax credit: A companion to the CHIPS Act, the Advanced Manufacturing Investment Tax Credit provides companies with a 25 percent investment. This should be expanded to all industries for investment in new machinery and equipment, with the credit increased to 40 percent for investments in federally designated labor surplus areas.
3. Include worker training expenditures under the R&D tax credit: Allow company expenditures on training rank-and-file workers to qualify as part of the new and expanded R&D tax credit.
4. Qualify expenditures on international standard-setting activities: Allow company expenditures on international standard-setting efforts to qualify under the new and expanded R&D tax credit. This is especially important since China uses such activities to promote technology standards that benefit its own companies.

These provisions would have three main positive effects. First, they would lower the after-tax cost of doing business in the United States for firms relative to other nations. Second, they would encourage (at least some) reshoring by both domestic and foreign advanced technology companies as they take advantage of these tax incentives. Third, they would spur firms in the United States to invest more in the building blocks of innovation, productivity, and competitiveness.

There would also be two additional institutional benefits. First, while Congress can always change tax laws, doing so is more difficult than it is for an administration or an appropriations committee to cut or eliminate industrial policy programs. A recent example being President Trump’s elimination of the NIST Manufacturing Extension Partnership. Second, administrations would not be able to impose their social policy priorities—whether “woke” or “anti-woke”—on these programs, as they are neutral and operate through the tax code.

What about the fiscal costs? Clearly, these incentives would not be cheap. In fact, they would lead to a significant reduction in corporate and business tax revenues. However, these losses could be offset if Congress implemented a border-adjustable value-added tax (VAT), as most other countries have. This would raise revenues without negatively impacting business investment, while also putting U.S. companies on a more level playing field with foreign nations. It would increase the costs of foreign products exported to the United States and help reduce the massive, unsustainable trade deficit.

Alongside this, Congress should pass legislation preventing the president from imposing tariffs without Congressional approval.

While some elements of this proposal will appeal to both Democrats and Republicans, others may not. Some Democrats may oppose the proposal because it could raise taxes on individuals (if a VAT is enacted) while cutting taxes on business—a change they see as exacerbating inequality. However, income tax cuts for business mostly benefit consumers, as competitive businesses will pass the savings along in the form of lower prices. In this case, the tax incentives would lead to greater investment, which would ultimately benefit workers through higher wages.

Some Republicans may oppose this plan as well, particularly because it could raise taxes (if a VAT is implemented). However, this could be done in a revenue-neutral way. Many Republicans favor the mantra “broaden the base, lower the rate,” seeing the ideal tax code as “neutral.” The reality is that a neutral tax code is not neutral to the national interest, as it does not prioritize investments America needs to beat the Chinese Communist Party.

Finally, in an ideal world, Congress would use both spending and taxes to mitigate the damage China is planning to inflict on America’s advanced technology economy, much like the CHIPS Act, which included both semiconductor grants and tax credits. But if Congress can gain bipartisan support for a China competitiveness tax incentive plan, then full steam ahead.