By Martin Tuchman on Jan. 17, 2011
Budget-cutting and increasing taxes alone will not reverse the worst economic downturn since the Great Depression. In fact, in the short run, most budget-cutting measures — i.e., cutting the defense budget, reducing the federal work force, freezing domestic discretionary spending — will increase the nation’s staggering unemployment rate. Increasing taxes is not a solution, since it removes capital from the most productive sector of job creation: the private sector. To solve our nation’s economic problems, we need to dramatically stimulate private investment.
The solution rests with the private equity firms that, coincidentally, are flush with cash, have a reasonable long-term view of infrastructure initiatives, and have a distribution system that can spread the risk and raise the capital over many markets. The one missing element is an incentive to pry loose the billions of dollars sitting on the sidelines.
One such catalyst could take the form of an investment tax credit (ITC). The nice thing about an ITC is that you only pay for success.
The tax credit serves two purposes. First, it allows the private equity firm to enhance its yield on the project by effectively reducing its initial cost by the amount of the tax credit. Second, it tends to reduce the risk, should the investment not work out as expected.
It is my opinion that this credit should be 25 percent, with 15 percent applied the first year, and 10 percent the second year.
Since this is a “success based” program, much of the tax credit will come back in terms of payroll tax, as a result of creating additional jobs, and as corporate taxes collected from the enterprise’s profits. It is important to note that every dollar of American manufacturing generates $1.37 in additional economic activity — more than any other economic sector.
It is necessary to act with some degree of urgency, not only because so many Americans have lost their jobs, but because many of those jobs have been permanently shifted overseas.
The situation is a bit complex, so I will simplify it by using a specific case.
There are two major manufacturers of refrigerated units and generator sets that are used by the maritime industry to keep at the proper temperature perishables shipped from the Far East to the West Coast of America. Once the refrigerated containers are removed from the vessel, they lose their electrical connection from the ship and must be plugged into a land-based generator set.
The two manufacturers are Thermo King and Carrier. Recently, Thermo King closed its U.S. factory and opened one in China. The U.S. workers were laid off, the factory dismantled and the operation moved to China, where long-term leases were signed, investments were made in employee training and a factory was built to produce the units in China. The cost to Thermo King is lower than it was before, for a variety of reasons: Labor, components, rent, local taxes, etc. are lower than in the U.S. In China, the government sets all of these items. No free market, no unions, no negotiations.
The generator sets are sold to vessel owners who are, for the most part, foreign operators. Thermo King is still owned by its shareholders. Indeed, its stock may be in the pension plans of many U.S. citizens. Eventually, when the timing is right, an offer will be made for Thermo King by a group of Chinese investors, perhaps sponsored by the Chinese government. The company will then be wholly owned by the Chinese. An entire industry will have left the U.S., never to return.
The workers and the owners will no longer be Americans. The vessel owners, users of this product, will be non-U.S. entities.
According to the Wall Street Journal article “Chinese Clones, Sells Russian Fighter Jets” (Dec. 5), it appears that a year after the collapse of the former Soviet Union, a cash-strapped Kremlin began selling China a portion of its vast military arsenal, including the pride of the Russian jets, the SUKHOV-27 fighter jet.
For the next 15 years, Russia was China’s biggest arms supplier, providing up to $30 billion in fighters, destroyers, submarines, tanks and missals.
After years of importing and reverse-engineering Russian arms, China has reached a tipping point; it can now build its own advanced weapons. In the past two years, Beijing hasn’t placed a major order from Moscow.
And so it will be with factories such as Thermo King. American workers’ jobs will be lost forever. Our labor force will continue to be under pressure as we relocate factories overseas.
There is, of course, little difference between protectionism and preservation of U.S. jobs. And as long as our unemployment rate is in the 4 percent to 5 percent range, we can afford, as a nation, to be magnanimous and take in goods and services that are either outsourced or made overseas.
However, once unemployment reaches 8 percent to 10 percent, it is time for an investment tax credit to free up the capital now held by private equity groups.
This is far more efficient than any kind of government-run stimulus package.