Chip Subsidy Flows – Comparing China and the U.S.
Grants, tax credits, technology parks, local IC funds, major strategic projects, human capital support...
[This week's Chip Capitols article is co-authored by my friend, Jiong FENG, a scholar of China's economic development.]
As the U.S. Department of Commerce prepares to open applications for CHIPS Act grants at the end of February, all eyes are on Washington to see how policymakers allocate an unprecedented $39 billion in taxpayer subsidies. Congress agreed to this rebirth of industrial policy amidst mounting concerns over supply chain security and economic competitiveness, and Commerce Department officials are scrambling to identify the industry holes they need to plug.
Across the Pacific, however, China prefers to let a hundred flowers bloom. Chinese semiconductor subsidies are much less centralized than those in the U.S., with different national and local programs experimenting with a range of policy tools. Additionally, whereas U.S. lawmakers have focused on incentivizing the construction of new semiconductor fabrication facilities (fabs), Chinese policymakers use public funds to both incentivize new chip industry developments and reward investments that have already been made.
These differences highlight the unique nature of each country’s approach to industrial policy: The U.S. tightly limits subsidies by only incentivizing activities companies would not otherwise do. This caution is primarily due to Americans’ concern over regulatory capture by big businesses. In contrast, China often rewards companies post-facto for exemplary investments supporting key areas of national development, suggesting that Chinese politics is more welcoming of government support for business.
Grants, tax credits, technology parks, local IC funds, major strategic projects, human capital support... The U.S. and China's semiconductor support programs use these tools to varying degrees, but the clearest division between them is whether government support comes before or after completion of a project. Today's article will:
Contextualize the industry conditions both countries seek to remedy,
Dive into the U.S. and China’s pre- and post- completion chip subsidies, &
Ask how semiconductor subsidies reveal different approaches to federalism and industrial policy.
Why Fund Chips?
Prior to diving into the U.S. and China's policy tools, we should reflect on what drives each country's policymakers. This section shows how differently situated semiconductor industries and different political contexts incline American and Chinese policymakers to choose different subsidization mechanisms.
U.S. Crisis Prevention
U.S. lawmakers are traditionally averse to subsidizing industry, with Democrats decrying such policies as "corporate welfare" and Republicans bemoaning distortion of the free market. A series of short-term supply chain disasters, however, combined with a long-term decline in the U.S.'s share of global semiconductor manufacturing to push American lawmakers into embracing industrial policy.
a) Supply Chain Challenges
In 2021 and 2022, nearly everything imaginable went wrong with the global semiconductor supply chain. At the onset of the COVID-19 pandemic, automobile manufacturers around the world canceled their orders for new chips fearing a sudden drop in demand for new cars. Meanwhile, consumer electronics companies and cloud service providers sharply increased their demand for the most advanced chips used in cellphones and 5G infrastructure. After a few months, however, the demand for cars rapidly recovered, but production lines for auto chips needed months to switch back into gear. Factories could not finish production without semiconductor inputs, leaving consumers without new cars and auto workers without jobs.
Beyond demand shocks, a slew of natural disasters exacerbated already tight supply for all sorts of chips. The February 2021 winter storm in Texas knocked out power for facilities across the state, including Texas Instruments facilities supplying analog chips for automobiles and Samsung’s facilities in Austin manufacturing advanced processors for 5G infrastructure and mobile devices. A March 2021 fire at a Renasas fab in Japan further strained automotive chip supplies, and in spring 2021 TSMC had to cut production due to a drought in Taiwan.
Longer term, the U.S. saw its share of chip manufacturing fall from 37% in 1990 to 12% in 2020. Meanwhile, Taiwan and South Korea formed a duopoly on the global supply of the most advanced logic chips at 92% and 8% respectively. Of greatest concern for U.S. policymakers, Mainland China’s share of global manufacturing has risen from 3% in 2000 to 15% in 2020.
b) Policy Response
These supply chain issues were serious enough to spur action by Congress. Because U.S. lawmakers are generally hesistant to subsidize private industry, however, the subsidies in the CHIPS and Science Act narrowly target the weakest links in the U.S.'s chip supply chain.
As the most acute crisis, lawmakers wanted to ensure funds would secure automakers' access to chips. A bipartisan letter by members of Congress and governors from states with significant automobile industries urged funding for the CHIPS Act to prevent car production from stalling and causing mass layoffs. This concern grew so acute, that lawmakers set aside $2 billion of the CHIPS Act's funding specifically for fabs producing the older generation (mature node) semiconductors used in vehicles.
In contrast to its declining share of global chip manufacturing, the U.S. retains 46% of global semiconductor design activity (a high value-add stage creating the layout and structure of a chip). So, when the semiconductor industry advocated for an investment tax credit for both manufacturing and design, Congress only agreed to support manufacturing. Not seeing a short-term or long-term crisis in American semiconductor design leadership, lawmakers were not willing to further interfere with the free market.
China’s Industrial Catch-Up
a) Supply Chain Challenges
China plays a critical role in the global semiconductor supply chain, accounting for over half of the world's chip demand. China’s indigenous industry lags behind, however, in its level of advancement. It lacks leading firms in advanced logic production, EDA tools, chip design IP, semiconductor manufacturing equipment, and semiconductor materials, resulting in “chokepoints” where it is largely dependant on imports. The only stage of the semiconductor supply chain where China commands the largest global share, chip assembly and packaging at 38%, is a relatively low value-add step.
Chinese policymakers are increasingly concerned about the impact of these chokepoints on China’s supply chain security. A rise in broad restrictions on China’s access to foreign semiconductor products impedes Chinese chipmakers’ growth, making the P.R.C.’s semiconductor supply chain more fragile and insecure.
b. Top Policy Guidance
In September 2022, President Xi Jinping announced the New Whole Nation System (新型举国体制), a system mobilizing resources nationwide to achieve breakthroughs in key technologies. In his report to the 20th National People’s Congress, President Xi reiterated the need to secure supply chains and become self-reliant in national security-critical technologies amidst escalating U.S. export controls.
Critically, China's socialist political system makes it easier to achieve national consensus on broad policy goals. It is then left to local governments to implement the central government's goals alongside their own goals and local conditions.
The key feature of China’s new Whole Nation System is the more important role of private industry. There was an old Whole Nation System during the era of President Mao Zedong that resulted in many successes, notably the 1960s development of nuclear bombs, but China’s old Whole Nation System focused on state and state-owned enterprises, without private sector or market involvement. Under the new system, government plays a leadership role at the macro-level while market rules dominate local ecosystems.
Importantly, the new system is centered around national strategy needs, targeting breakthroughs in dual-use technologies critical in both the military and commercial realms. Key priorities include next-generation telecommunications, artificial intelligence, biotechnology, new energy, new materials, advanced manufacturing equipment, green industry, and integrated circuits (semiconductors).
For the integrated circuit industry in particular, local governments set specific targets during the “14th Five-Year Plan” development period. For example, Beijing is aiming to spend 300 billion yuan ($43 billion) on the industry, Shanghai 100 billion yuan ($14 billion), Chengdu 200 million yuan ($28 billion). Other localities set development targets, instead of spending targets. For example, Hubei plans to develop five semiconductor equipment and materials companies with sales topping 1 billion yuan ($0.14 billion) in 2025, and Shaanxi similarly plans to refine its semiconductor and integrated circuit industry chains.
“Let’s See Your Plans First”: Pre-Completion Subsidies
Providing public funds prior to completion of a project gives governments maximal control over the types of activity they incentivize. These pre-completion subsidies involve application processes, through which companies must demonstrate how their projects align with policy goals. Governments in turn scrutinize the applicant's proposed budget to ensure they only spent the minimum amount of public funds needed to incentivize activity within their jurisdiction.
United States
GRANTS – The U.S. CHIPS Act's crown jewel is a $39 billion fund incentivizing companies to expand semiconductor manufacturing capacity in the U.S. Eligible projects include semiconductor fab construction, purchases of chip manufacturing equipment, and factories producing semiconductor tools and materials.
Companies can apply for grants of up to $3 billion per project (or more if the President permits a larger grant), and these grants need not be repaid. $2 billion of the $39 billion fund is reserved specifically for mature node manufacturing to support automotive chip supply chains, and Congress issued non-binding guidelines saying national security critical projects shouldbe prioritized. Other than the auto chip set-aside and non-binding priority guidelines, however, the Secretary of Commerce exercises wide discretion in deciding who receives funding. Congress explicitly gave the Secretary this discretion so she could prioritize funds for areas in which the U.S. has lost global leadership.
By nature of these being pre-completion grants, companies can only apply for funds if they have either not yet begun construction or still have significant work left before completion. This allows the Commerce Department to ensure applicants 1) be financially capable of maintaining the facility after completion, 2) secure additional support from local governments, and 3) document what types of chips or equipment they plan to produce (as well as to whom they plan to sell).
LOAN GUARANTEES – In addition to the primary tool of issuing grants, the Secretary of Commerce can also use up to $6 billion of the $39 billion fund to make or guarantee loans. Though there is reason to doubt how popular these loans will be, Commerce Department officials have argued this tool gives them greater flexibility to maximize the fund’s impact. As with the grants, this is a pre-completion tool that allows the Secretary of Commerce to screen applicants for their financial soundness and the relevance of their projects to the U.S.'s semiconductor supply chain needs.
STATE & LOCAL TOOLS – Nearly all semiconductor-specific incentives on the state and local level in the U.S. also function as pre-completion grants. Local politicians share federal politicians' concern over padding companies' profit margins with taxpayer dollars, so local programs similarly focus on supporting projects that would not otherwise be financially competitive in their jurisdictions. (Notably, the federal CHIPS Act's manufacturing grants require applicants to have also received support from a state or local government. This results in applicants being screened twice, once by the federal government for alignment with nationwide supply chain needs, and once by local governments for alignment with local job creation needs.)
States including Texas, Arizona, New Mexico, and Ohio offer incentives in the form of tax credits to incentivize semiconductor manufacturing in their jurisdictions. Texas' Chapter 313 credit gives local governments the power to reduce chipmakers’ property tax liabilities by $10 million to $100 million, as for Samsung in Austin. Arizona's Qualified Facility credit empowers its Commerce Authority to issue up to $125 million every year in tax credits to companies, like TSMC. New Mexico's Local Economic Development Act authorizes its Economic Development Department to approve tax rebates for strategic projects, like Intel's chip packaging facility. And Ohio's Job Creation credit allows its Tax Credit Authority to refund tax liabilities on the basis of job creation, issuing over $400 million to Intel. These local tax credits may appear to be post-completion subsidies because companies do not receive benefits until after making expenditures. However, eligibility under all these state programs requires approval by a government authority, making the mechanisms pre-completion subsidies.
Though tax policies are more common, some states also use grant tools for strategic economic development. The Texas Enterprise Fund offers "deal-closing" cash grants based on a potential project's economic benefit to the state, with Samsung receiving $27 million for its fab. Similarly, Ohio's economic development agency, JobsOhio, issues grants to attract strategic projects, like Intel's fab. As with the federal CHIPS Act grants and state-level tax credits, these grants are entirely discretionary, making them pre-completion tools.
China
GRANTS – China's local governments issue grants to support new investments in integrated circuit design, electronic design automation (EDA) tool development, the R&D and production of manufacturing equipment, and advanced material production. For example, Shanghai reimburses 30% of new investment in such projects mentioned above up to 100 million yuan ($14 million). These grants, subject to application review, allow the Shanghai government to incentivize chip firms’ investment in China’s supply chain chokepoints. Here, the mechanics of grants function similarly as those under the U.S. CHIPS Act, but they are directed even more narrowly at key strategic areas.
INDUSTRIAL CLUSTER GRANTS – Industrial clustering helps firms use resources more efficiently and increases their competitiveness by lowering switching costs between competing providers. Accordingly, local governments promote cluster development by using grants to draw chip firms to designated high-tech zones. In 2023, the city of Hefei in Anhui Province included settlement incentives of up to 5 million yuan ($720,000) in its integrated circuit industry development plan. Hunan Province in 2022 similarly planned a total of 50 million yuan ($7 million) to encourage integrated circuit companies to build a chip industry cluster in its high-tech zone.
DIRECT INVESTMENT –
Major Construction Projects: Projects selected as national or local “major construction projects” get direct investment from the central or local governments, receiving both monetary investments and eased permitting. For instance, Shanghai announced in 2023 it would invest at least 215 billion yuan ($31 billion) across all its major construction projects, covering 17 semiconductor projects by SMIC (中芯国际半导体), Jita (积塔半导体), Geke (格科半导体), etc.
National Integrated Circuit Industry Investment Fund: China's largest state capital-backed semiconductor investment vehicle (a.k.a. the "Big Fund") is propeling China toward its goal of building a world-class semiconductor industry amid urgent calls from Beijing to increase technological self-reliance. Each phase of the Big Fund exists as a stock corporation, an independent entity. This investment flows directly to companies, not to local government or industrial parks as funds from other national-level policy tools do.
The first phase of the "Big Fund" raised 139 billion yuan ($20 billion) in total and invested in 81 projects by 23 listed companies from September 2014 to May 2018. There are 16 shareholders in the first phase of Big Fund, among which the Ministry of Finance accounts for the highest at 36.47% and the rest shareholders are all SOEs. Among projects receiving investment, integrated circuit manufacturing accounted for 67%, chip design 17%, packaging and testing 10%, and equipment/materials 6%. Currently, funds from the first phase have started exiting via buybacks, M&A, and IPOs.
In October 2019, the Big Fund’s second phase was established, aiming to raise 201 billion yuan ($29 billion). Besides government and SOE contributors, some private companies also joined this round, though the Ministry of Finance still accounts for the largest share at 11.02%. As of March 2022, the second phase fund has announced 79 billion yuan ($11 billion) in investments in 38 companies, with design accounting for 10%, packaging and testing 2.6%, and equipment/materials 10%.
TAX – Integrated circuit enterprises registered on the Chinese mainland meeting certain standards qualify for tax benefits. The State Council policy excuses corporate income tax for the initial five years of a semiconductor project and levies a reduced rate of 10% in the following years. The requirements allow the government to ensure enterprises have technological achievements in line with national development goals.
LOAN GUARANTEES – Jiangsu encourages all financial institutions in the province to offer an average 1% interest guarantee fee to all integrated circuit companies. It is not clear how this tool is actually implemented, so it is hard to say whether government authorities exercise much discretion in choosing which projects’ financing to support.
“Bravo, Here’s Your Prize”: Post-Completion Subsidies
If the value of pre-completion subsidies is that they are more likely to incentivize investment that would not otherwise occur, the strength of post-completion subsidies lies in their ability to deepen firms' commitment to jurisdictions they have already entered. Companies can only receive post-completion subsidies if they keep or (in some cases) continue expanding facilities in a specific jurisdiction. This creates a long-term bond with the incentive-providing government that grows hard to cast off.
As this section will demonstrate, however, the dynamics of post-completion subsidies vary significantly between the U.S. and China. Whereas in the U.S. all semiconductor projects fitting statutorily defined criteria automatically qualify, Chinese post-completion subsidies are as discretionary as pre-completion support. To that end, Chinese government agencies can also use post-completion tools to advertise exemplars of the projects they want to promote.
United States
TAX – The FABS Act's advanced manufacturing investment credit is the U.S.'s only semiconductor-specific policy functioning as a post-completion subsidy. Passed in the same CHIPS and Science Act that funded the manufacturing grant program, the FABS Act offers a 25% tax credit for investments expanding semiconductor fabrication and manufacturing equipment production in the U.S. Any company that spends money on a qualifying project automatically qualifies for the credit, so the Treasury Secretary has much less discretion over the activities receiving this incentive than the Commerce Secretary does over manufacturing grants.
China
Compared with the U.S., China often rewards companies post-facto for exemplary investments supporting key areas of national development. These post-completion subsidies on the one hand help recipient chip firms grow capacity and invest in key technologies, and on the other hand incentivize firms not yet having been rewarded to follow “model” firms’ lead.
GRANTS – Integrated Design Manufacturers (IDMs) in Hefei investing over 10 million yuan ($1.44 million) in equipment qualify for grants totaling 15% of fixed assets expenditures (capped at 20 million yuan). Qingdao grants IDMs with annual income exceeding 100 million yuan, 500 million yuan, and 1-billion-yuan one-time rewards of than 1 million yuan, 3 million yuan, and 5 million yuan, respectively. Hengqin has announced one-time rewards of up to 5 million yuan ($720,000) for newly established or newly moved enterprises whose paid-in capital is not less than 10 million yuan.
TAX – Many local governments reduce corporate income tax rates for both enterprises engaged in semiconductor manufacturing and those engaged in research. For instance, Shanghai's Lingang district levies a reduced rate of 15% for five years from the date of establishment. Jiangsu has implemented similar preferential tax policies for qualified integrated circuit companies.
INNOVATION REWARD – In terms of supporting semiconductor integrated device manufacturers (those who do both upstream design and downstream manufacturing) to develop new products, the Hefei’s innovation reward policies propose that enterprises relying on their own core technologies to develop new products will be rewarded up to 3 million yuan for each new product developed that provincial or municipal authorities recognize as significant.
LABOR CONTRACT REWARD – To help attract high-skilled talent, Hengqin has implemented the labor contract reward policies offering companies rewards of up to 150,000 yuan ($21,000) annually per R&D and senior management employee who signs a labor contract of at least three years with integrated circuit companies or scientific research institutions in Hengqin’s cooperation zone.
We’re all subsidizers now.
The U.S. and China face different challenges in the semiconductor industry and operate under different political systems. While analysts often summarize national semiconductor incentive programs in aggregate dollar/yuan terms, it is critical to look under the hood and understand how supply chain and political realities give rise to particular policy tools.
Different eras and different locales call for governments to take different approaches to supporting their semiconductor industries. As most major markets have now passed their own semiconductor support programs, policymakers around the world should learn from each other's experiences and continually evaluate the tools they use at home. Chip Capitols will continue drawing these lessons with future articles examining semiconductor incentive policies in Taiwan, South Korea, Japan, the European Union, and beyond.
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