Santoronomics — A Mixed Report Card

Rick Santorum is magnificently right about tripling the individual tax credit, and doubly right to warn about demographic winter in America. But he’s wrong to propose a special tax break for manufacturing. As an admirer of Santorum, I offer some friendly criticism.

It’s encouraging that Rick Santorum emerged as the leading conservative alternative to Mitt Romney. Unlike the mercurial Newt Gingrich, a man whose contributions to political life are manifold but who is temperamentally unsuited to the presidency, Santorum is a truly nice guy. And as my one-time mentor Jude Wanniski liked to say, the American people want a nice guy in the world’s most powerful office. As a prominent Orthodox rabbi of my acquaintance put it, it says something about American faith that the frontrunners are, respectively, a devout Mormon and a devout Catholic, and exemplary husbands and fathers.

Full disclosure: I have contributed to both Romney’s and Santorum’s campaigns, to the former because I think Romney is the best man to face Barack Obama in the general election, and to Rick Santorum because I like him.

Santorum’s program calls for reducing the number of tax rates to only two, namely 10% and 28%, and tripling the personal deduction for each child (to about $10,000). I would go even further and scale Social Security and Medicare contributions to family size; as I wrote three years ago in First Things, “For most taxpayers, social-insurance deductions are almost as great a burden as income tax. Families that bring up children contribute to the future tax base; families that do not get a free ride. The base rate for social security and Medicare deductions should rise, with a significant exemption for families with children, so that a disproportionate share of the burden falls on the childless.” This is simply a matter of fairness. It costs about $400,000 to raise the average American child through grade 12, the government tells us. If everyone spent that $400,000 on vacations instead, and no-one raised children, we would all die of starvation upon retirement. Families that spend that $400,000 (and much more, counting college) are raising the next generation of taxpayers without whom we are dead. Those who fail to have children and spend money on other things are free riders. As a matter of simple equity, they should pay more.

By focusing on family issues, Santorum’s personal tax program gets an A+ on my scorecard. Less convincing is the special treatment he proposes for manufacturers (complete elimination of corporate income tax, vs. a 50% reduction for everyone else). If there are profitable opportunities in manufacturing, why won’t American investors seek them out with the same incentives that apply to services? There’s no shortage of success stories in manufacturing. Germany’s unemployment rate is the lowest in a generation, in part due to its success in manufacturing exports from heavy machinery to autos. And the average German manufacturing wage is about $40,000 a year, not much different from the American level.

Why does China run on German, rather than American, machine tools? Why is Manhattan’s 2nd Avenue (not far from my home) full of German-made earth-moving equipment? Why don’t Americans compete at the high-value-added end of the manufacturing spectrum? It’s not because Germans are smarter. American universities remain the best in the world. It might have something to do with the fact that the cleverest and most ambitious graduate students chose law and investment banking as careers, rather than mechanical engineering. Germany is the turtle beating the hare, at least for the moment; because Germany’s anti-entrepreneurial culture did not favor investment banking, more Germans went into engineering and got jobs in family businesses that dominate the field.

If that’s the case, the gutting of financial-sector employment will free a lot of talent for manufacturing, and we won’t need a special manufacturing tax break. Another part of the problem is regulatory paralysis. If that’s true, what we need is regulatory rollback (which Santorum also supports), not a special tax break.

Whatever the problem is, a special tax break for manufacturing will cover it up, and subsidize inefficient manufacturing. Why should the rest of us pay more taxes to hire less-than-efficient workers in manufacturing plants?

In some ways, the whole idea of separating goods- and service-producing industries is absurd. Why should a software company selling industrial controls pay a higher tax rate than a manufacturing company that uses these industrial controls? In many industries, the availability of industrial software is what makes the whole enterprise profitable to begin with. Is software a “good” or a “service”? If you download it online, it’s a “service,” but if you buy a disk, it’s a “good.” Increasingly, enterprise software is moving towards a cloud-computing model in which users “rent” the software on the web, rather than purchase a product and install it. As manufacturing becomes increasingly software-intensive, the goods-services distinction will get blurrier.

Santorum’s corporate tax program gets a C- on my scorecard. His heart is in the right place, and he wants to do the right thing, but he’s getting some dubious economic advice.

This is not a deal-breaker, to be sure. Good candidates sometimes entertain awful ideas — for example, Mitt Romney’s dreadful demagoguery about China. Santorum’s emphasis on family economics counts for more than his manufacturing muddle. The Republican Party has had far worse choices than Romney vs. Santorum.