American trade warriors, fresh from victories over Europe’s restrictions on imports of foreign bananas and hormone-fed beef, are about to get a taste of their own medicine.
The European Union later this month would rack up a major victory over American exporters if the World Trade Organization, as anticipated, overturns a huge export subsidy in the federal tax code. The WTO is expected to rule that a tax loophole designed to shelter the foreign earnings of U.S. conglomerates from federal taxes represents an illegal subsidy under the new global rules of trade.
For U.S. exporters like Boeing Corp. and computer software firms like Microsoft Corp., which are among the largest beneficiaries of the special tax break, losing the loophole would represent a huge hit on the bottom line. A final ruling banning foreign sales corporations, which are paper subsidiaries set up in tax havens like the Virgin Islands or Barbados to shelter overseas earnings, could cost U.S. firms as much as $1.8 billion a year.
The ruling also would set a precedent for European challenges to other export-friendly provisions in the tax code, just months after the U.S. won the right from the WTO to slap $308 million in countervailing duties on luxury European goods, such as Italian handbags and French pate, in disputes over U.S. banana and meet exports.
But the coming decision has more at stake than a short-term gain for U.S. taxpayers, trade experts say. Those gains would come at the expense of the long-term erosion of national sovereignty represented by the recent trend in rulings under international trade law, they say.
According to a new study by the Corporation for Enterprise Development, a Washington-based think tank critical of traditional economic development policies, the collateral damage from this latest trans-Atlantic trade spat will be felt beyond Washington. In statehouses and city halls across America, policies to help exporters could come under fire.
“Buy-American laws, state export financing and economic development subsidies, job training for industries adversely affected by imports, programs to help businesses cope with foreign competition–all could become susceptible to challenge from this precedent,” said Robert Stumberg, a law professor at Georgetown University and co-author of “Could Economic Development Become Illegal in the New Global Policy Environment?”
“The taxpayers may have gotten a ruling that will save them money, but they may be losing the ability to spend money on productivity-enhancing investments that can save jobs in American communities,” he said.
The case stems from the Agreement on Subsidies and Countervailing Measures, which prohibits many subsidies to exporters and forbids laws that show preference for domestic suppliers.
With tariffs and other overt trade barriers rapidly falling around the world, negotiators are expected to focus on indirect subsidies to trade during the next round of talks. The issue is expected to a major bone of contention when senior officials from the 144-member WTO meet in Seattle in late November to kick off the talks, which have been dubbed the Millennium Round.
But the biggest protests against new anti-subsidy rules will come outside the meetings, where thousands of representatives from environmental, community and other non-government organizations will gather to protest the latest developments in international trade law. Many of the protests will focus on fears that recent treaties are being wielded by trade-hungry companies and their governmental promoters to get around other nations’ domestic laws that regulate environmental protection and workers’ rights.
Now they are adding local or national efforts to resuscitate poorer regions and cities to their list of activities threatened by international trade accords.
To date, U.S. non-governmental organizations have focused concerns about lost sovereignty rights on the North American Free Trade Agreement, which gives companies in the U.S., Mexico and Canada the right to challenge any law that gives domestic producers preferential treatment in the “establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of investments.”
Companies under NAFTA are also accorded a vaguely defined right to “fair” treatment and the right to file individual complaints under the treaty. But those complaints are not heard in national courts: They go before an arbitration panel at the World Bank, which is empowered to order compensation by the national government if any policy measure is “tantamount” to expropriation.
The European Union complaint against U.S. Foreign Sales Corporations was filed at the WTO a little over a year ago. Congress passed the FSC law in 1984 to spur exports among manufacturers then reeling from overseas competition. It allowed firms to set up off-shore paper subsidiaries to book their profits from overseas sales.
Under the law, half the profits in the paper subsidiaries were permanently exempt from U.S. tax. Major users have included companies in the transportation, agricultural, chemical and machinery businesses. The law was expanded in 1997 to include computer software firms, which will collectively reap an estimated $700 million in benefits by 2002.
The WTO preliminary ruling, which called the law an unfair trade practice, was warmly greeted by EU Trade Commissioner Sir Leon Brittan. “The FSC scheme is clearly contrary to the WTO obligations, which are binding on the U.S.,” he said. “This export subsidy has created a major distortion of international trade by granting a very substantial unfair advantage to U.S. products.”
The U.S. Trade Representative’s office will undoubtedly appeal any adverse final ruling. Trade Representative Charlene Barshefsky issued an earlier statement saying the WTO panel disregarded relevant history and its own rules on income taxes.
Many taxpayers around the world would undoubtedly welcome a WTO-sanctioned campaign against tax subsidies for exporters. Not only are national tax codes in the U.S. and Europe filled with loopholes designed to benefit big business, but many state and local governments in the U.S. and abroad offer large-scale tax subsidies to persuade corporations to locate within their borders.
But economic development experts worry that these state and local subsidies aren’t the ones that will come under WTO scrutiny, because they are usually offered to foreign firms as well as domestic ones. Rather, they fear the only local economic development laws that will be challenged are the ones that foreign firms have difficulty meeting.
“Laws linking purchasing to local suppliers or local employment or joint venture requirements with minority businesses are the ones that can be charged with building a bias against foreign firms,” said Georgetown’s Stumberg. “It is the most accountable economic development incentives that could be challenged.”
