THE
U.S. government currently doles out more than $5 billion a year in tax breaks to
domestic firms that set up "foreign sales corporations" abroad. By rattling
around Bermuda for a few nanoseconds, American firms can shield up to 15 percent
of their export income from taxes.
The World Trade Organization (WTO) has
ruled that this deliberate loophole in U.S. tax law amounts to an illegal export
subsidy (which it is) and has authorized the European Union to impose
retaliatory tariffs (up to 100 percent) on more than $4 billion worth of U.S.
exports if the United States doesn't eliminate it.
With red ink gushing
from every window of the Capitol, you might think Congress would use this WTO
ruling as a convenient excuse to shave a small amount of corporate welfare from
the budget, but you would be wrong. Instead, lobbyists for large firms are
lining up behind one of two competing proposals in the House Ways and Means
Committee, each of which preserves the full $5 billion in tax breaks.
For
any reform to pass muster with the WTO, the tax break cannot be directly
connected to exports. There is no way to write a bill that satisfies global
trade rules and that leaves every beneficiary of the old tax break unharmed, so
the lobbying sweepstakes are quite high.
Committee chair Rep. Bill
Thomas, a California Republican, has offered a proposal that replaces the export
subsidy with one that reduces taxes for firms that have significant overseas
production. Multinational firms such as Ford, General Motors and ExxonMobil are
salivating.
The dissent is bipartisan. Reps. Philip M. Crane, an Illinois
Republican, and Charles B. Rangel, a New York Democrat, are sponsoring an
alternative proposal that cuts the corporate tax rate from 35 percent to 31.5
percent on all manufacturing. Under either proposal, firms that produce in the
United States but whose business is global will be the big losers. This includes
giants such as Boeing and Eastman Kodak.
The discussion thus far is less
about what constitutes good tax policy and more about how each proposal affects
individual firms' profits. Export subsidies generally are counterproductive and
ought to be eliminated. They help export-oriented firms expand using capital and
labor that otherwise would have been employed by a different set of U.S. firms.
And there is nothing particularly virtuous about selling to Germans instead of
to Americans. Export subsidies also induce in-kind retaliation that threatens
stable trade relations, which is why the WTO is so hostile to them.
But
the two competing proposals aren't sound, either.
The Thomas plan rewards
firms that shift production overseas, but multinational firms are no more
virtuous than firms whose plants and headquarters are located in the United
States. Mr. Crane and Mr. Rangel would shift the tax benefit from exporters to
all domestic manufacturers, yet there is nothing superior about producing
manufactured goods instead of services.
The fundamental problem is that
the U.S. and European tax systems do not fit together properly. American firms
owe taxes to Washington based on their worldwide income. European countries use
a "territorial" system. They do not tax the foreign earnings of their firms, but
they do tax the earnings of foreign firms that operate within their
borders.
To deal with this difference, the United States has been forced
to develop a complex and ever-evolving system of foreign tax credits and
exemptions to mitigate the double taxation faced by export-oriented U.S. firms.
This complexity offers ample scope for lobbying money to work its
magic.
By focusing narrowly on the U.S. tax code, Congress is trying to
slap a Band-Aid on a festering wound. Perhaps it's time for a joint venture
between both ends of Pennsylvania Avenue.
Tax harmonization talks between
the United States and the European Union offer the opportunity to streamline and
simplify our corporate tax code while engaging Europe in productive global
problem-solving.
David H. Feldman teaches economics at the College of
William & Mary in Virginia.
