Tax Incentives: Benefit or Future Burden?

The fairness of tax system debate took an interesting turn this week as the European Commission ruled that tax deals granted to Starbucks and Fiat amounted to illegal state subsidies.  This could prove to be a landmark decision as countries have increasingly engaged in a "race to the bottom", where they offer dramatically lower tax rates and other incentives in return for large companies relocating part or all of their business to that country.  Countries due so with the hope of increased employment, tax revenue and other benefits.

Europe is not the only area where this phenomenon is occurring and this is by no means solely a recent phenomenon.  In 2001, Boeing engaged in a public auction as it looked to relocate its corporate headquarters from Seattle.  Chicago ultimately offered the most lucrative package, with the total value amounting to $56 million.  In the years since the Great Recession, feeling the sting of low growth, individual states offered increasingly aggressive packages in attempts to lure companies. In 2009, South Carolina won a Boeing 7E7 production line by offering a package estimated at $900 million dollars.

Supporters make clear the reasons they think these packages are justified.  Per the WSJ, "Proponents of corporate-tax subsidies said the incentives are a drop in the bucket, compared with the return to a state’s economy."  These supporters argue that to truly understand the benefits, you need to look at the overall rate of return, not just what the package costs.

However, as competition for these companies has increased, so has the size of the financial packages, which are beginning to cause a drag on state's budgets. The WSJ states, "in Oklahoma, where officials are grappling with a $300 million budget gap, Jeff Hickman,a Republican and speaker of the state House of Representatives, is calling for greater scrutiny of the $1.7 billion he said the state gives away each year on tax credits, incentives and exemptions."  A program that was sold to the public as increasing jobs could in reality be increasing the budget deficit and thus negatively affecting citizens.

The upshot is that citizens should always be wary of programs whose benefits are based on uncertain and fuzzy direct and indirect benefits.  States should continue to improve the business climates in their states and look for creative ways to attract investment.  However, they must also be more objective and transparent on projected benefits to ensure that voters can understand the true costs of such incentive packages and that future citizens are not saddled with heavier tax burdens.

Infrastructure: The Curious Case of Bipartisan Support and Lack of Action

Infrastructure!  Many seem to agree that the US is in dire need of an infrastructure upgrade. The Chamber of Commerce points out that "our interstate system is nearly 70 years old, and more than 61,000 bridges are labeled as deficient."  Even budget conscious Republicans see the need with Senator Deb Fischer (R-Neb) introducing legislation that would create a national Infrastructure bank. Heck, even President Obama can get behind this goal.  Per the think-tank American Progress, "On the campaign trail, the president repeatedly called for directing to infrastructure the federal spending saved by ending the wars in Afghanistan and Iraq, asking for those funds to support nation building right here at home.”  Yet here we are again, racing against the clock to pass another temporary measure that would allocate spending for the next three months on already approved infrastructure projects.  This would be the 35th time since 2009 where Congress has passed such a temporary measure.

In this cost conscious environment, it appears that lawmakers feel little pressure from their constituents to get a long-term deal done which illustrates an interesting paradox.  In 2014, infrastructure did not even crack the Top 20 for issues most important to Americans.  At the same time, citizens have direct exposure to many of the consequences of America's failure to maintain and improve its infrastructure.  Drivers tweet about constant stop and go traffic during their morning commutes in Los Angeles and Atlanta.  Passengers bemoan terrible conditions and long waiting lines at airports across the United States.  Citizens attribute these inconveniences to a myriad of causes (damn you United!), however as of yet have failed to make the connection with the lack of a national, long-term infrastructure plan.  Unfortunately, aging airline terminals and potholes aren't the only consequences from this consistent neglect of our infrastructure.  The WSJ reports that urban highway congestion costs the economy more than $100 billion annually.   The Journal also notes that billions are added to the costs of products Americans consume daily due to port congestion, lock delays and a lack of facilities. 

A lack of infrastructure spending and planning is an unseen weight around the US economy's shoulder and is choking growth.  The next time you are stuck in that traffic delay and tempted to deal with it via a witty Twitter post, consider instead thinking about the real root cause.

The Dilemma of China

Cisco's recently announced partnership with Chinese server maker Insur group illustrates the evolving challenges companies are facing as they attempt to thrive in China.  With slowing global growth, finding success in China's market is increasingly imperative for companies in every industry. However, China is taking advantage of this market power by favoring domestic companies and creating an environment where foreign companies are forced to partner with Chinese companies and thus risk losing their competitive advantage,

Why China?
Despite the recent volatility and underwhelming growth numbers, China's attractiveness as a market for a wide range of companies is obvious.  China's middle class continues to explode in size.  In 2001, the share of the Chinese population who were middle class was 1%. 10 years later, that share is 18%. Companies are eager to meet the demand created by these people with newly found purchasing power. In natural resources, China accounts for 49% of global coal consumption, recently became the largest importer of oil and is the second largest consumer of gold.  In 2010, China became the largest market for automobiles. Simply put, companies ignore the Chinese market at their own peril.

Increasing Difficulties
Sounds great right?  Problem is, with low growth elsewhere, companies are increasingly dependent on China for growth, and the Chinese government is well aware of this fact. The Chinese government is increasing its influence on the way foreign companies operate in the country, partially in an attempt to give its domestic companies a leg up.  The Chinese government is leveraging its power over domestic companies to encourage them to focus their business on domestic Chinese companies at the expense of internationals. Cisco is a prefect example.

Cisco's Chinese Experience
Cisco long resisted the partnership model in China, preferring to rely on its brand and expertise during its 20 years operating in the country.  Following this strategy led to impressive success. In 2014, Cisco controlled 21.2% of the Chinese server market.  However, this dominance is being challenged by domestic Chinese competitors, particularly Huawei, who are being steered business by the Chinese government.  In 2015, Cisco's share of the Chinese server market dropped to 9.4%.  Much of this decline can be attributed to the Chinese governments decision to remove Cisco (as well as other US companies such as Apple, Citrix and McAfee) from a government approved purchase list for small contracts amid concerns by the Chinese government that the US government had installed so-called backdoors into US made networking gear. Regardless of the reasoning behind the decision, this is a poignant example of the Chinese governments ability to determine winners and losers in its economy and its emphasis on supporting domestic companies.

What's Next
This trend has no end in sight. Companies will continue to struggle with the trade off of the massive financial potential of the Chinese market with the risk of sharing technological know how with Chinese partners who, with the assistance of the Chinese government, may soon become a competitor.