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Policy Options for U.S. Export Taxation, September 21, 2006 1 (September 21, 2006)

handle is hein.tera/crstax0191 and id is 1 raw text is: Order Code RS21143 Updated September 21, 2006 CRS Report for Congress Received through the CRS Web Policy Options for U.S. Export Taxation David L. Brumbaugh Specialist in Public Finance Government and Finance Division Summary Prior to 2004 the Extraterritorial Income (ETI) provisions of the U.S. tax code provided a tax benefit for exporters. ETI, like the Foreign Sales Corporation (FSC) provisions they replaced, was designed to boost U.S. exports. The European Union (EU), however, filed complaints with the World Trade Organization (WTO), charging that ETI and FSC were export subsidies and so violated the WTO agreements. In a succession of rulings, the WTO upheld the EU's charges, and authorized the EU to levy retaliatory tariffs on U.S. goods. The EU began a phased-in application of tariffs in March 2004. Several policy options for the United States were proposed in Congress, including retaining ETI and accepting whatever tariffs would be imposed; overhauling the U.S. method of taxing foreign-source income by adopting a territorial tax system; reforming the U.S. tax system in general by adopting a consumption tax similar to the value-added taxes levied by European countries; attempting negotiations with the EU; and repealing the ETI provisions while replacing them with tax cuts elsewhere. The last of these approaches was ultimately taken by Congress in October 2004 with the enactment of the American Jobs Creation Act (AJCA; P.L. 108-357). Although the EU lifted its tariffs in January 2005, it also lodged a WTO complaint against transition provisions in AJCA, which had the effect of rescinding the ETI only gradually in certain cases. In May 2006, a provision of the Tax Increase Prevention and Reconciliation Act (P.L. 109-222) repealed the transition rules, apparently bringing an end to the long- simmering controversy. The Economics of the ETI Provisions To understand the implications of the various policy options that were considered, it is useful to first look briefly at the basic economic effects of ETI and its predecessor, FSC. The FSC provisions allowed U.S. firms to exempt between 15% and 30% of export income from taxation; ETI provides a tax benefit of roughly the same magnitude. The tax benefits attract investment to the U.S. export sector and, as a consequence, U.S. exports are probably higher than they would be without the provisions. Beyond this effect, however, traditional economic theory indicates that the export benefits produce a set of effects that are perhaps surprising to non-economists. First, because of exchange rate adjustments, the FSC/ETI-induced increase in exports is diminished, and U.S. imports Congressional Research Service oe The Library of Congress

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