Charting Some of Industrial Policy’s Opportunity Costs

Adam N. Michel and Scott Lincicome

In the last few years, Congress has authorized as much as $2.1 trillion in domestic subsidies for preferred industries such as steel, semiconductors, and electric vehicles—a flood of taxpayer cash that supporters have cheered for boosting U.S. manufacturing and the economy more broadly. As Cato scholars and others have long cautioned, however, a proper assessment of industrial policies’ efficacy requires considering far more than a simple correlation between new government spending and new private investments, jobs, and products. Among the necessary considerations is the spending’s opportunity cost, i.e., what Congress—operating in a world of finite budgets, time, and political capital—could have done with these trillions instead of industrial policy.

To help clarify that point, we’ve considered one alternative to U.S. industrial subsidies that Congress could have pursued: improved tax treatment (so‐​called “full expensing”) of companies’ domestic capital investments. As Michel explains in a new Cato paper out this week, current tax law discourages innovation and private investment in the United States by requiring that business tax deductions for spending on research and development, equipment, and construction be spread out over long periods. The 2017 tax law temporarily addressed some of this problem, but as the law now expires, new U.S. investments have again become more costly.

Delaying investment deductions erodes their value over time—especially in times of high inflation. For example, the most innovative U.S. businesses are only able to recoup as little as 83 percent of their real research costs under the current (pre‐​tax reform) regime. By contrast, allowing businesses to recoup their full investment deduction immediately through permanent full expensing would significantly boost associated investment, employment, wages, and economic growth more broadly (and especially investment in capital‐ and research‐​intensive projects such as semiconductor manufacturing). Expensing also avoids the capital misallocation, cronyism, and other costs that—as Lincicome has documented—too often result from targeted industrial subsidies (including the new ones that Congress just authorized).

This smart, pro‐​growth policy, however, isn’t free—a broad tax reform package would likely lower federal tax revenues by hundreds of billions of dollars over a 10‐​year budget window. Yet, as shown in the following chart, even the most aggressive, pro‐​growth expensing package would still be dwarfed by the amounts that Congress has just spent on industrial policy via the Infrastructure Investment and Jobs Act (2021), the Chips and Science Act (2022), and the Inflation Reduction Act (2022).

In particular, the Congressional Budget Office (CBO) estimates that the Infrastructure Investment and Jobs Act’s will spend about $517 billion over 10 years, possibly rising by as much as $100 billion due to higher contract authority in the second half of the decade. CBO further calculates that the Chips and Science Act will cost $79 billion over 10 years, including about $50 billion in direct funding and $24 billion in tax credits. If Congress appropriates the remaining funds in future years, as planned, the cost of the legislation could increase to almost $280 billion. Estimates of the industrial policy spending in the Inflation Reduction Act are much higher. Goldman Sachs and the Joint Committee on Taxation calculate that the energy subsidies will, depending on various assumptions, cost between $645 billion and $1.2 trillion over 10 years.

In each of the estimates, we’ve focused on the spending that is intended to put the federal government—not private investors—at the center of directing the location, timing, and inputs of elected officials’ preferred economic activities. Given that industrial policy estimates vary, we provide both lower ($1.2 trillion) and higher ($2.1 trillion) totals. We provide something similar for full expensing: a lower bound estimate using only neutral cost recovery for structures and an upper bound estimate that lets structures be immediately expensed in full. (Neutral cost recovery simply allows deductions for investments in structures to be indexed for inflation and time.)

As Figure 1 shows, the industrial policy spending is as much as four times as costly as a pro‐​growth tax reform package, and even the more conservative industrial policy estimate exceeds the more aggressive expensing estimate by more than $300 billion. Of course, this isn’t really a fair comparison because, at best, the subsidies will just reallocate existing resources, whereas pro‐​growth tax cuts would expand the pool of total private investment and, just as importantly, put private investors—not politicians—in charge of determining where new investments should go.

Of course, tax reform isn’t the only pro‐​market policy that should have been pursued instead of those trillions in new government spending. As Lincicome has explained repeatedly, for example, both regulatory reform and liberalization of current U.S. trade and immigration restrictions would undoubtedly benefit capital‐​intensive, high‐​tech manufacturers in the United States. But looking at tax policy is particularly apt, given that Congress actually chose to let certain full expensing provisions expire right as it was implementing new subsidies in 2021 and 2022. As of last year, research and development spending—including related wages and other associated costs—can no longer be immediately deducted, and starting this year, full expensing for other business investments begins to phase out.

In short, it’s a perfect (albeit depressing) example of what Congress could have done to boost domestic investment and economic growth instead of industrial policy—with more economic benefits, less political favoritism, and at just a fraction of the budgetary cost.