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GEC Commentary No. 10
Repealing the Extra-Territorial Income Act
On April 19 the U.S. Senate resumed debate on a longdelayed bill to repeal the Extra Territorial Income Act,
ruled illegal by the World Trade Organization in 2002.
Repealing ETI became a matter of urgency in March,
when the European Union initiated retaliatory tariffs
(starting at 5 percent and scheduled to rise by 1 percent
per month) on American exports. Under a bipartisan
compromise brokered by Majority Leader Bill Frist, Senate
conferees have agreed to phase out ETI over a three-year
period while reducing the corporate tax rate on U.S.
manufacturers from 32 to 35 percent.
On the surface, the Senate compromise appears to
resolve WTO objections and thus clear the way for
suspension of the EU’s $4 billion trade sanctions. The
corporate tax reduction would apply to all U.S.-based
manufacturers, satisfying the WTO’s non-discriminatory
rules while compensating American exporters for the loss
of ETI. The bill would also shut down offshore tax shelters
and close loopholes in the international tax code, affording
both Republicans and Democrats political cover in an
electoral season distinguished by unprecedented public
rancor over the foreign activities of American companies.
However, final resolution of the ETI matter confronts three
major hurdles:
Pork Barrel Politics To break the legislative logjam over
ETI, Frist negotiated a deal allocating 30 floor
amendments to the Democrats and 47 to the Republicans.
Predictably, this arrangement instigated a flood of special
interest provisions bearing little or no connection to the
underlying export subsidy issue. Senators from both
parties indulged in the pork barrel frenzy, whose zeal
surprised even hardened veterans of Congressional
politics. Minority Leader Thomas Daschle (D-South
Dakota) joined Charles Grassley (R-Iowa) to obtain $94
million to rehabilitate a hotel in the border town of Sioux
City, while Bob Graham (D-Florida) and Lisa Murkowski
(R-Alaska) co-sponsored a provision to relieve taxation of
the foreign earnings of cruise ship operators. Jeff
Bingaman (D-New Mexico) won $189 million in assistance
for car dealers, while Jon Kyl (R-Arizona) obtained an
extension of the depreciation schedule for NASCAR
grandstands.
The cumulative costs of the special tax breaks now
inserted in the Senate bill—$170 billion—threaten the
original legislation’s commitment to revenue neutrality.
The ETI spectacle also raises serious concerns about the
U.S. government’s ability to insulate foreign economic
policy from pork barrel politics in the run-up to the WTO’s
Doha Round, the success of which hinges on the
resolution of equally troublesome trade issues (e.g.,
agricultural subsidies).
House of Representatives A heated debate over an
even costlier ETI bill is underway in the House. In an
attempt to mitigate the fiscal impact of the House version,
Ways and Means Chairman Bill Thomas is sponsoring a
revised bill that would limit the ten-year reduction in
corporate tax receipts to $3 billion. But the Thomas bill is
encountering opposition by House Democrats (joined by
some 25 Republicans) who oppose granting any tax
breaks to U.S. companies with foreign operations.
Aggressive lobbying by American exporters reeling under
the EU sanctions makes it likely that Senate and House
legislators will bridge their differences and allow a
conference bill to reach the desk of President Bush, who
has signaled his readiness to sign an ETI repeal despite
White House misgivings about the exclusion of service
companies from the corporate tax reduction. But whether
such a compromise will prove fully WTO-compliant
remains to be seen.
VAT vs. Income Taxes Even if Congress produces an
ETI repeal bill acceptable to President Bush, the
underlying source of this latest U.S.-EU
dispute—transatlantic differences in systems of corporate
taxation—will persist. The EU’s reliance on Value Added
Taxes (which the WTO considers “indirect taxes”) enables
European exporters to obtain rebates for the embedded
VAT component of foreign sales prices. Reliance on direct
income taxes in the United States deprives American
exporters of such rebates, compelling policymakers to
devise compensatory export subsidy schemes that run
afoul of WTO rules. This places American policymakers in
a conundrum: An international tax reform that would place
U.S. and European exporters on truly equal footing is
unlikely to pass muster with the WTO.