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Notes from Regional Strategic, Ltd.

Why We Can’t Make Nice Things…

This all started with some import-export data from the United States Bureau of Economic Analysis (BEA) and a couple of import-export graphs from the Economic Research Service (ERS) of the United States Department of Agriculture (USDA). It is not really about imports and exports in general, however, or even agricultural imports and exports in particular. It is about how our international transactions are influenced by the United States’ system of taxation. In particular, it is a discussion of how the United States’ tax system disadvantages labor relative to other factors of production and how that disadvantage affects our transactions with the world.

The graph below is “Export value share of production, 2013-22” for U.S. agricultural and food production. While we are just looking at industry production shares and not total volumes, it is clear that U.S. agricultural and food exports are heavily weighted towards relatively nonperishable commodities, low value food products. The majority of U.S. agricultural products are non-manufactured and non value added. Since 2008, the export share of U.S. agricultural production has remained relatively constant at about 20 percent.

The second graph is “Import share of U.S. food consumption, 2011-21.” The accompanying explanatory notes indicate that imports accounted for 15 percent of U.S. food consumption for the period, and that they steadily grew as a consumption share over the period. The unstated takeaway is that imports must be significantly above 15 percent of U.S. food consumption now.

As in the export graph, we are looking at industry shares rather than total volumes or values. It is still clear, however, that U.S. agricultural and food imports are skewed towards perishable and value-added food products – high value stuff. The explanatory notes also suggest that this is due to, “…numerous factors – including relative competitiveness in production…,” but no explanation for the, “…relative competitiveness of production…,” is given. It is assumed that relative competitiveness is a given – a state of nature.

It is not.

One of the reasons the U.S. exports nonperishable, non-manufactured, low value-added agricultural products and imports perishable, manufactured, and high value-added products is the competitive position of labor within the U.S. We often hear about the competitive position of labor between the U.S. and other countries, but that is not what we are discussing here.

The uncompetitive position of labor within the U.S. is largely a creature of the U.S. tax system. The tax system penalizes labor utilization within the U.S. in a number of ways. In general, taxes on labor are high. Income taxes, which are levied on wages and salaries, earned income, are substantially higher than taxes on capital gains, which are levied on incomes derived from physical and financial capital. This artificially raises the cost of labor in production. It also artificially lowers the cost of capital in production.

Income taxes are also generally levied on gross earned income and are collected immediately upon payment. Labor has very few means of minimizing or deferring their share of taxes. Labor pays gross rates. In addition, the U.S. government funds very large components of its social expenditure package (Social Security and Medicare) with direct taxes on labor. All of these increase the production cost of utilizing labor. It also increases the participation threshold of labor in production, making it less likely that labor will participate in the production process.

Conversely, recipients of receipts from physical and financial capital benefit from multiple incentives that can reduce rates that are already favored over labor (and further distort investment decisions). Among these is a very favorable schedule of depreciation, allowing owners of physical capital to claim a significant portion of receipts during the depreciation cycle as expense deductions. Recipients of returns from capital also have substantial leeway in determining when and how to realize those returns. This allows them to time and combine their receipts in tax-advantaged ways. When they do realize those returns, the recipients pay taxes at filing time rather than upon receipt. They pay net rates rather than gross rates. Furthermore, a large proportion of receipts from returns on capital is self-reported, generating substantial opportunities for tax avoidance.

Taken together, U.S. tax policy raises the relative cost of utilizing labor and lowers the relative cost of utilizing capital in the production process. At this point, one might ask, “What the heck does that have to do with the industry distribution of agricultural imports and exports?”

The answer is relatively simple. High-value food products, perishable, manufactured, and specialty foods, are generally more labor intensive than low-value foods. Through its tax policies, the U.S. disadvantages local production of high-value foods and encourages the production of low-value foods. This is mirrored in the types of food the U.S. exports and imports. There are other factors, but U.S. tax policy is a significant factor in this imbalance.

Tax policy doesn’t just affect employment and production in agriculture. Its effects are economy-wide. Luxury cars and watches are not generally products of the United States. Premium handmade shoes are generally imported, as are handmade suits. We export relatively capital-intensive goods and services. We import relatively labor-intensive goods. Both trends are supported by a domestic tax system that penalizes labor (earned incomes) and rewards physical and financial capital (unearned income).

If you recall your international trade course in undergraduate economics, trade is determined by relative input cost differentials within countries. Movement between countries equalizes internal cost differentials for both partners regardless of single-factor cost differentials between them. That means we can alter our import and export mix with the rest of the world by reducing the tax policy distortions between earned and unearned income. We are often told that unfair competition is stealing American jobs, but before anyone can be accused of cheating, we need to stop driving American jobs away with a distortionary tax regime.

In addition to the artificial cost differentials between labor and capital, the practice of funding social benefits through taxes on labor builds the cost of pensions and health care into the cost of goods on the market. This directly penalizes domestic consumers, and it increases the prices of U.S. exports, making labor-intensive exports even less competitive on the world markets. In most industrial nations, pensions are paid through general taxation and do not directly translate into export prices. In many, such benefits are paid for through value-added taxes that are only levied on goods sold domestically. This makes exports from these countries more competitive than exports from the U.S.

The tax distortions also cause fundamental economic problems and political distortions. While producers face artificially high costs of labor due to taxes, labor gets artificially low returns due to those same taxes. As a result, productive labor is often not an attractive trade-off with respect to the informal economy or household production. High labor costs due to taxes are coupled with low returns to labor due to taxes. We end up with:

  • A labor to capital cost differential that distorts our production and international trade
  • Stagnating labor incomes
  • A shortage of labor

All tied to a tax regime that penalizes earned income and rewards unearned income.

Recipients of unearned income recognize there are distortions in the labor market, but they have no interest in giving up their tax advantages. As an alternative, they insist that U.S. labor is paid too much. They fight to reduce the rights of labor to organize. They fight to reduce labor regulations that address fair payroll practices, overtime payments, working hours, and child labor. In order to get labor costs back in line, they fight to further reduce returns to labor while also defending and expanding the tax differentials that are the root of the problem.


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