The WTO Kibosh on a U.S. Tax Break

On Aug. 30, a three-judge panel of the World Trade Organization issued its final ruling in a trade dispute that dates back to the Nixon Administration. The international court authorized the European Union to impose penalty tariffs on U.S. exports to Europe by as much as $4 billion a year, by far the largest penalty ever against any of the 144 nations in the Geneva-based trade organization. And the WTO decision represents a complete victory for the Europeans.

At the heart of the dispute is a $4-billion-a-year tax break, called the Foreign Sales Corporation [FSC], for U.S. exporters. The panel ruled last January that the tax loophole is illegal and, on Aug. 30, set the penalty. The aim of the ruling is to pressure the U.S. to repeal the tax breaks permanently. What does all this mean? BusinessWeek's Paul Magnusson explains it for you:

A: That's up to the government of the European Union. If they wish, they can levy 100% tariffs against $4 billion worth of U.S. exports. The Europeans get to choose the category and the amount. Or, they can demand that the U.S. lower or remove an equivalent amount of tariffs on European goods as a compensation. Washington would probably be reluctant to pick which tariffs to lower on imports from Europe, so it's more likely the Europeans will just raise their tariffs on imports from the U.S.

A: It's a very big deal for the largest U.S. exporters. According to the National Foreign Trade Council [NFTC], 3.5 million American jobs depend on the income-tax break declared illegal by the WTO. A third of $1 trillion in goods and services exported from the U.S. are supported by the tax break. That accounts for 3.4% of the nation's gross domestic product, according to the NFTC, which supported the tax break.

Boeing for example, reduced its taxes by $685 million from 1991 to 1998. That accounted for 10% of the company's entire revenue at the time, according to a study by Jose Oyola at the University of Virginia. Other big beneficiaries: General Electric Motorola, Caterpillar, Cisco Systems, and Archer Daniels Midland. Still, the vast majority of the tax breaks go to just a couple dozen of the biggest U.S. companies.

A: The U.S. exporting companies set up a branch office in a foreign tax haven, usually in the Caribbean. The office is basically a front, however, intended to generate paperwork showing that the foreign sales branch purchased and then sold the goods to be exported. In reality, the foreign branch usually has no employees and does nothing. But the paper arrangement allows the parent company to deduct 15% of its export earnings from income taxes.

A: President Richard Nixon proposed the idea to Congress when the U.S. started running big trade deficits in the late 1960s. It was originally designed to provide taxpayer subsidies to U.S. exporters so they could lower the prices of goods sold abroad, sell more of them, and thus reduce the trade deficit. The trade deficit kept climbing, but U.S. exporters appreciated the effect the tax break had on their bottom lines. Later, Washington claimed that the income-tax break was justified by the fact that Europeans and many other countries rebate sales taxes on their exports. Europe's Value Added Tax [VAT], a sales tax, is rebated on exports, for example.

A: Not according to the WTO. The WTO trade rules, agreed to by the U.S., clearly state that sales taxes -- but not income taxes -- can be rebated on exports. The U.S. knew that, but insisted before the WTO panel that it had reached a "gentlemen's agreement" with Europe that the FSC tax break was O.K. But Europe disagreed, and the U.S. couldn't point to any formal agreement. In fact, the Europeans have been protesting the U.S. tax break almost from the beginning. And the U.S. also rebates sales taxes on its exports.

Q: Didn't Congress pass legislation in November, 2000, to fix the problems with the FSC that WTO rulings had exposed?

A: Congress passed a revision of the original FSC tax-break language and renamed the loophole the Extraterritorial Income Exclusion Act [ETI]. But the bill contained mostly cosmetic changes. The ETI was essentially written by lobbyists for big exporters, and it actually expanded the tax break under the guise of rewriting it. The Europeans cried foul and when another WTO panel looked at the result, it ruled the ETI illegal last January.

A: They'll draw up a list of possible tariffs on U.S. exports, but it's unlikely they would impose them immediately. The list would be designed to pressure the U.S. into repealing the FSC/ETI once and for all. The House Ways & Means Committee is considering legislation written by Chairman Bill Thomas [R-Calif.] that would revamp much of the U.S. international tax code and do away with the tax break. President Bush also has promised European trade minister Pascal Lamy that Washington intends to comply with the WTO ruling. So far, Lamy has said that such promises are sufficient and the European Union will hold off for a while, as long as Washington makes progress.

And the U.S. also rebates sales taxes on its exports.

I'd say this is a bit misleading - the U.S. doesn't have a sales tax - the individual states do for items sold within the state (at the retail level.) Do the E.U. corporations pay an income tax similar to the U.S., or was this WTO deal just a scheme to tip the scales away from U.S. exports. (Who signed off on the WTO and why?)

My understanding of the VAT is that it is not just paid at the retail level - every middleman along the way (including the retailer) pays it on the difference between the price paid and the price sold. It is not the same as a sales tax, and if it is the primary means of collecting tax from E.U. companies, they should either collect their tax or allow us to waive ours (and skip all of the Carribean phony paperwork.)

sadly, we don't have people in washington representing us who are willing to actually act in our interest. maybe the tooth fairy will save us.

Our founding fathers thought that our congress should make our laws and that our executive branch should follow them and enforce them. But today we believe that the executive branch's negotiators should agree with foreign countries what our laws should be and that then our congress should change the laws to conform to the agreements made by the negotiators.

Also, prior to 30 years ago the actual welfare of the american people mattered first and foremost to our representatives in washington. If you merely exclude the 1930-1945 period and look at unemployment figures, the average unemployment rates prior to 1970 was 25-30% lower than what it has been after 1970. Prior to 1970 it was common for unemployment to be measured under 3.0%, even as low as 1.0%. But after 1970 we never see it go below 4%. The minimum wage today is lower than it was in 1965 after adjusting for inflation. We have a new set of priorities now, those priorities are rooted in politically correct ideologies, not in the welfare of the american people.

The establishment's actions show that they are more concerned with the entrepenuers in China than with the average american citizen. I say this because over the last 15 years our establishment has consistently negotiated trade deals where we charge the chinese practically nothing in tariffs for their products exported to us, but the chinese impose tariffs 3, 4, 5 or 6 times what we impose and then on top of that impose large limits as to what we can export unlike us. Our government has actually sided with their interests instead of ours'.

Take the h1b program. We have 1 million people with h1b visas working in america today. We have a few hundred thousand others who have endured h1b and either gotten green cards or citizenship status. But the actual h1b workers don't pay social security tax. Funding the social security program is traditionally thought of as one of the most important functions of the federal government. But with h1b they transfer one million jobs that would pay 75 grand a year to people who make only 50 grand a year and then we don't collect the 15% social security tax on that amount every year. In other words we sacrifice 10 billion a year in funding to social security for the sake of h1b. Then for each h1b person, after they become citizens they bring in their families and this increases greatly the burdens that social security must fund. This is civilizational suicide.

Our leaders, both republican and democrat do not represent us and our interests at all.

BA didn't really have sales of only $6.85 billion in the years 1991 to 1998, as implied by the statement quoted above. The article probably means that $685 million is the amount of reduced taxes BA enjoyed on total foreign exports of approximately $40 billion or more in those years.

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