Taxation ; Manufactures ; Tobacco industry ; Federal Reserve District, 5th

Charles Gerena

English

Research Papers in Economics

P
resident Bush signed the American Jobs Creation Act on
the eve of his 2004 re-election. Among other things, the
legislation contains accounting changes and tax breaks
intended to benefit various sectors of the national economy, 
from restaurant owners to producers of biodiesel fuel. It may
even stave off a trade war by repealing a tax break on the
export income of manufacturers called an extraterritorial
income exclusion (ETI). The ETI had angered the European
Union enough to impose tariffs on U.S. exports last March.
The Jobs Creation Act will affect two bedrocks of the Fifth
District regional economy: manufacturing and tobacco.
Hello, Tax Deduction
While some manufacturers lose the
ETI, many more will gain from the cor-
nucopia of provisions in the Jobs
Creation Act. For one thing, they will
receive more than $8 billion of tax
breaks over the next three years to off-
set the impact of the ETI repeal. 
In  addition, manufacturers will be
able to deduct 9 percent of gross
income generated by “domestic produc-
tion activities,” minus certain items.
The deduction phases in over the next
five years.
The bill’s definition of “domestic
production activities” includes com-
modities that aren’t traditionally con-
sidered manufactured goods, including
construction projects, television
shows, and electricity. While this
broad description is meant to spread
the benefits of the deduction widely, it
also adds confusion to an already con-
voluted tax code.
“You are going to create incentives to label activities
within the firm as production that may or may not be 
production. That’s going to lead to a lot of paperwork 
for the IRS and the accountants,” says Kimberly Clausing, 
an economist and tax policy expert at Reed College 
who has closely studied the provisions of the Jobs Creation
Act. Indeed, PricewaterhouseCoopers expressed its con-
cerns about the uncertainties surrounding the deduction 
in a recent report to its clients.
Clausing thinks it makes little sense to stimulate the 
economy by creating yet another deduction. Instead, tax 
simplification and a reduction in corporate tax rates would 
be better, she says. “You wouldn’t be handing well-connected 
people windfalls. You would generate economic activity
because the marginal incentive to do things is going to be high-
er when our rate is lower relative to our foreign counterparts.”
Bye-Bye, Price Supports
In the Fifth District, the provision of the Jobs Creation Act
that has garnered the most attention has been the “Fair and
Equitable Tobacco Reform Act,” which eliminates federal
price supports and the quota system that controls tobacco
leaf production. To soften the blow, quota holders and
tobacco growers will receive annual payments over the next
10 years, up to a maximum of $9.6 billion. 
The tobacco subsidy program began during the Great
Depression to help farmers cope with falling prices. Since
then, it has succeeded in keeping
domestic tobacco prices up and
domestic production down, says
economist Richard Ault at Auburn
University. That hasn’t been good for
tobacco product manufacturers
because they want greater flexibility
and more stability in their supply.
Higher tobacco prices also “created
an incentive and an opportunity for 
imported tobacco to come into the
market,” Ault says. “In the last 20 years,
other countries have developed tobacco
that is a very good substitute for high-
quality American tobacco, particularly
Brazil.” As U.S. tobacco production has
fallen and quotas have been lowered,
quota holders have watched their
assets diminish in value. Ault says that
is why they have been anxious to be
bought out by Uncle Sam.
As for farmers, those who hold
quotas will immediately benefit from
the annual payments they will receive. Also, they will no
longer have to buy or rent quotas to increase production. But
some may see the value of their land drop because plots with
tobacco quotas associated with them commanded a premium
that no longer exists. Eliminating tobacco subsidies will also
remove a major justification for the warehouse-based auction
system, which offers farmers an alternative to direct con-
tracts with manufacturers. Only tobacco sold at auction is
eligible for price supports, not tobacco sold under contract. 
The transition might be painful for some, but econo-
mists like Ault believe that agricultural subsidies can’t work
in a global economy.   “All countries are finding that, in the
face of foreign competition, subsidy programs are becoming
more and more burdensome,” he says. RF
LEGISLATIVEUPDATE
Big Changes for Regional Manufacturing and Tobacco Sectors
BY CHARLES GERENA
Winter 2005 • Region Focus 5
The Big Tobacco Payoff
North Carolina will get the biggest chunk of 
the federal tobacco buyout: 41 percent of 
the $9.6 billion total payout over the next 10
years. Maryland wasn’t included in the buyout,
while West Virginia received very little money.
NOTE: Adding owner payments and grower payments
may not equal total buyout payments due to rounding.
SOURCE: Agricultural Policy Analysis Center, University 
of Tennessee
0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
North
Carolina
South
Carolina
Virginia
Quota Owner 
Payments
Grower 
Payments
Total Buyout 
Payments
P
A
Y
M
E
N
T
S
I
N
M
I
L
L
I
O
N
S
RF Winter 04 FINAL.ps - 1/10/2005 13:56 PM

Legislative update: Big changes for regional manufacturing and tobacco sectors

http://www.richmondfed.org/publications/research/region_focus/2005/winter/pdf/legislative_update.pdf

Legislative update: Big changes for regional manufacturing and tobacco sectors

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