Taxes are sinking U.S. shipping

Gary Hufbauer

April 27, 1993|By Gary Hufbauer

AS CONGRESS struggles with the first Clinton budget, i should recall a lesson from 1986 when members last wrestled with major changes in the U.S. tax system. The Congress presumably did not want to tax the U.S. ocean-going fleet out of business. In 1986, it just wanted to raise a little extra money. Yet Congress forgot the laws of international competition. The result was to push the U.S.-controlled shipping fleet rapidly toward extinction.

Arthur Laffer may have claimed too much for his famous curve when he argued that lower tax rates would raise U.S. tax revenues across the board. Yet Mr. Laffer was surely right: In important instances, higher tax rates actually curtail the amount of tax collected. This happens because the tax base shrinks as employees and owners play avoidance games, reduce their work effort or simply go out of business.

In the Tax Reform Act of 1986, the U.S. Congress managed to enact a tax that vindicates Mr. Laffer's basic proposition. In its last-minute rush to balance the revenue figures (if only on paper), Congress enacted a gaggle of complex foreign tax provisions, all designed to squeeze revenue out of offshore activities, most of them misguided.

Among these measures, the most conspicuous failure was the tax on foreign earnings of the U.S.-controlled shipping fleet. According to a GAO study, the new shipping tax miserably failed to raise the revenue promised -- an additional $160 to $240 million over five years, or about $40 million a year. Instead it nearly sank the last vestiges of the U.S.-controlled merchant fleet.

While the tax details are mind-numbing, and mainly of interest to chronic insomniacs, these are the facts in summary:

Before 1986, U.S.-controlled ships paid U.S. tax on their foreign earnings at the normal corporate rate if the earnings were not reinvested. In 1986, however, the U.S. disallowed deferral (i.e., postponement but not forgiveness) of U.S. taxes for earnings reinvested in the shipping industry. The change was rushed through Congress on the superficial argument that shipping should be taxed like any other industry.

The problem is that shipping is not any other industry. U.S.-controlled ships compete for cargo with ships controlled by Taiwanese, Danish, British, German, Norwegian, Japanese, Greek and other owners. The shipping industry is highly capital-intensive, so collection of the U.S. tax whether or not earnings are reinvested significantly adds to the cost of doing business.

While the details of foreign tax codes are almost as mind-numbing as the U.S. Revenue Code, the bottom line is simple: Foreign countries do not tax foreign earnings of their shipping corporations.

Hence, with repeal of the reinvestment rule in 1986, the U.S.-controlled fleet has operated at a significant cost disadvantage by comparison with its foreign competitors -- not because it is less efficient, but merely as a result of hasty U.S. tax rules.

The outcome is not surprising. Shortly after the U.S. repealed the reinvestment rule and started to tax its merchant ships, the U.S.-controlled fleet began to vanish. Between 1986 and 1991, the U.S. fleet dropped from 17.1 million gross tons to 12.3 million gross tons, a decline of 28 percent.

The problem was not a shrinking shipping industry worldwide. During this same period, the open world fleet rose from 126 million gross tons to 157 million gross tons, a rise of 25 percent. But today, only 10 of the top 100 container carriers that transport general cargo in the U.S. foreign trade are still U.S.-owned or controlled.

With quick action, the endangered U.S. fleet can be saved. Congress can undo the damage inflicted in 1986 by a simple step: reinstate the reinvestment rule. Since the 1986 law raised little revenue, its reversal should be scored as costing little revenue.

Even if careful evaluation shows that an offsetting revenue pickup is needed, there is a way taxes might be generated without decimating the U.S. shipping industry. A very low excise tax on gross tonnage could be imposed on all vessels clearing U.S. ports, whatever their flag and ownership. For example, a tax of 10 cents per ton would raise approximately $50 million annually.

There is no such thing as a perfect tax, but a 10-cent tonnage tax, coupled with the reinvestment rule for the U.S. fleet, would at least solve the problem of vanishing American ships and disappearing revenue.

Gary Hufbauer is a senior fellow at the Institute for International Economics and former director of the international tax staff of the U.S. Treasury Department.

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