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Analysis: Tax break goes far beyond the factory floor

By Kim Dixon

WASHINGTON (Reuters) - President Barack Obama summons the image of a scrappy auto worker or high-tech engineer when he calls for expanding a major corporate tax break for manufacturing, but he might just as well evoke the coffee-shop barista or the cable guy.

Broadening the $18 billion-a-year deduction for American manufacturing is a cornerstone of Obama's plan to revamp corporate taxes. Under the plan, all corporations would be subject to much lower tax rates, with even bigger breaks for manufacturers.

A Reuters analysis of company filings and government data shows how broadly the deduction is now used, suggesting it may be nearly impossible to keep it focused on manufacturing. Corporate America's army of tax lawyers will be at the ready.

From Starbucks Corp to Time Warner Cable Inc, businesses far beyond traditional manufacturers use the benefit, Reuters found.

"If you are in the Dow Jones industrial (average), and you are not taking this deduction, there must be something wrong," said John Harrington, a former U.S. tax official now at law firm SNR Denton. "It has always applied to a motley crew of activities."

The deduction has become so deeply embedded in the economy that one-third of corporate activity qualifies for it, the Congressional Research Service said in a report last month.

Obama wants to cut the top corporate tax rate from 35 percent to 28 percent, with a special 25 percent rate for manufacturing.

At the same time, he wants to double the deduction for "advanced" manufacturing, which he has not defined, and cut the break for oil and gas companies.

Obama has traveled to Iowa, Wisconsin and other states to tout the tax break, which is known as Section 199.

"In America, there's always something we can do to create new jobs and new manufacturing and new security for the middle class," the president said in February.

Critics say the manufacturing focus is in large part politics as Obama faces a potentially tough re-election fight in battleground states such as Ohio and Pennsylvania, where manufacturing is important.

Meanwhile, Congress is unlikely to take any action on the tax breaks until after, perhaps long after, the November 6 vote.

STARBUCKS FOOTNOTE

Enacted by Congress in 2004 amid concerns about jobs leaving the United States, the tax break began as a 3 percent deduction from income derived from property manufactured, produced, grown or extracted there. Since 2010, most companies have gotten a 9 percent deduction.

Pointing to the complexity, a congressional report on the law includes what is known as the "Starbucks Footnote," which states that food processing qualifies, but not retail activities.

That said, lawmakers made an exception that allows establishments to allocate a section of gross receipts for the break to the extent that roasted beans are used to brew the coffee.

Starbucks, the eponymous coffee giant with nearly $12 billion in revenue in its last fiscal year, takes the deduction.

The company said it had helped trim its tax rate by 0.8 percentage point in fiscal year 2011 and cut its 2009 rate by more than 2 points, according to a regulatory filing.

Starbucks spokesman Jim Olson said the deductions reflected the income from work at the company's four U.S. roasting plants, which employ 800 people, not from brewing espresso at retail stores.

Time Warner Cable, with $20 billion in revenue in 2011, reaped a $14 million benefit from the break in 2011, filings at the U.S. Securities and Exchange Commission showed.

A spokesman declined to comment.

Filings show other users of the deduction include satellite TV provider DirecTV, which said the break helped cut its 2011 tax rate, and sports, media and entertainment company Madison Square Garden Co, which said the deduction helped defray fourth-quarter expenses.

HAMBURGERS TO MINING

Companies classified as manufacturers claimed $12 billion of the $18 billion in Section 199 tax deductions in 2008, the latest year that government data is available. Some critics argue that, on a relative basis, other industries benefit more.

The tax break accounts for 0.2 percent of all manufacturing deductions, but it comprises about 0.5 percent of all deductions used by mining companies and 0.7 percent of those used by publishers, according to the data.

"What happens is people game the system," said Will McBride, an economist with the conservative Tax Foundation think tank.

Robert Atkinson, president of the Information Technology and Information Foundation, a think tank funded in part by technology companies, said that even though hamburger makers might benefit, cutting the deduction would harm manufacturers.

"Many of the models that economists use still think we are a closed economy where we don't really compete with other countries," he said at a Senate hearing this week.

CARVE OUT?

It may be impossible to tell how much the benefit preserves U.S. jobs, especially as manufacturing continues to ebb. It will probably drop to 7 percent of the labor market by 2020, down from about a third in the 1950s, according to government forecasts.

Obama's Simpson-Bowles commission on cutting the U.S. deficit recommended killing Section 199, the part of the IRS tax code that provides for the tax break. It proposed removing tax breaks while simultaneously lowering rates for all companies.

Many tax experts contend that Obama's bid for a special manufacturing carve-out moves in the opposite direction. Lawmakers in Congress now are laying the groundwork for a revamp of the entire tax code, a process expected to take years.

(Editing by Kevin Drawbaugh, Howard Goller and Lisa Von Ahn)

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