U.S. Exports Face Record Penalties

The World Trade Organization on Friday authorized the European Union to impose a record $4 billion in penalties on American goods unless the United States eliminates a controversial tax break for U.S. exporters deemed illegal under global trade rules.

The long-anticipated decision raises the pressure on Congress to push forward on tax reform or risk a trade war that would jeopardize $1 billion a day in transatlantic trade and further depress the fragile global economy.

Under WTO rules, the European Union could impose as much as $4 billion in duties on food products, airplane parts, aluminum and other imports from the U.S. The exact items have yet to be determined. The $4 billion in duties is believed to be 20 times greater than the previous record for WTO-approved sanctions.

With so much at stake for Brussels and Washington, the EU immediately declared its intention to hold off on any penalty as long as the U.S. makes progress toward resolving this long-running dispute over conflicting tax policies.

EU Trade Commissioner Pascal Lamy said Friday’s decision provided “major incentive for the U.S. to eliminate this huge illegal export subsidy” within a “short period of time.”

“Before any countermeasures are taken, we will carefully evaluate progress made on U.S. implementation,” he added.

The question is whether the U.S. can move fast enough on such a complex issue to hold off frustrated EU bureaucrats who are unhappy about other recent American trade actions, including steel tariffs and farm subsidies.

U.S. Trade Representative Robert B. Zoellick voiced unhappiness about the size of the penalty, because the U.S. had argued that the fine should be no more than $1 billion. But he and other U.S. officials, including congressional leaders from both parties, insisted they were working on legislation to comply with the WTO decision.

Rep. William M. Thomas (R-Bakersfield), who chairs the House Ways and Means Committee, has submitted a bill that would do away with the offending tax break while providing other types of tax relief for U.S. multinationals. Companies such as Boeing Co., Caterpillar Inc. and Microsoft Corp. were among those that benefited from the disputed law.

Sen. Charles E. Grassley (R-Iowa), ranking member of the Senate Finance Committee, said he was disappointed by the WTO’s decision and was particularly concerned that farmers would bear the brunt of penalties.

“That said, I believe it’s critically important the United States comply fully with the rule of law,” he said in a statement Friday, adding that “the ball is in our court.”

A ballooning budget deficit and weak economy will make it tough for Congress to push forward on tax reform in the coming months, particularly with fall elections fast approaching.

That means it won’t be until next year before politicians get serious about fixing this problem, according to U.S. tax and trade experts.

“The weak investment picture is leading a lot of people to talk about savings and investment incentives, which might take up a lot of available money for tax changes,” said Stephen Entin, president of the Washington-based Institute for Research on the Economics of Taxation.

The heart of the dispute involves the Foreign Sales Corporation tax law passed by Congress in 1971, which allowed firms to exempt a portion of their income obtained from overseas sales. But the EU complained that the U.S. was, in effect, creating an export subsidy through its tax law and filed a complaint that was upheld by the WTO in 2000.

The U.S. later amended the law, but in January the WTO ruled that the revised law still violated trade rules. Friday’s decision simply set the size of the penalties that the EU could impose.

Critics of U.S. tax law, including Rep. Thomas, say the U.S. should move to a territorial system in which the government taxes only income earned within its borders--a system similar to what is used in Europe and most of the world.

The U.S. currently uses a global system in which it taxes income earned abroad as well as in the U.S., although it does provide a break to companies that have paid taxes to another government.

In the interim, his proposed legislation would simplify the tax requirements for international traders, lessen the likelihood firms would face double taxation on income earned abroad and increase the incentives for U.S. firms to stay at home rather than seek tax havens abroad.

“The longer we wait to reform our uncompetitive tax code, the more jobs we lose to foreign competitors,” Thomas said in a statement Friday.

Gary Hufbauer, a senior fellow at the Washington-based Institute for International Economics, believes that the immediate problem is with the WTO.

He says the Geneva-based trade group should revise its rules to recognize key differences in tax policies and allow governments to take measures to level the playing field.

“The international rules now are truly lopsided,” he said.