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.