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WTO Disallows U.S. Tax Breaks

Trade: Backing European view, the agency rules against sheltering of income from foreign sales. American firms could face up to $4 billion in duties.


The World Trade Organization ruled on Monday that a tax break for U.S. exporters was illegal, opening the door for Europe to impose as much as $4 billion in duties on U.S. exports as punishment.

Unless the United States repeals or amends its tax code, it could face a bitter trade war with its European allies as well as the largest penalty imposed in the six years that the Geneva-based WTO has been regulating commerce. A WTO panel is scheduled to meet in late March to finalize the duties and to decide which exports will be targeted. The list could include airplanes, chemicals, toys and food.

Relations between the United States and Europe were already strained over threatened U.S. penalties on steel imported from Europe and elsewhere. Given the financial stakes and the fragile state of the global economy, many officials say they expect the U.S. and Europe to craft a face-saving compromise that will avoid a costly trade war.

"The timing is very unfortunate because the companies most hurt by this are in the industrial sector, and we're in the midst of the worst industrial recession since at least 1980-81," said Tom Duesterberg, president of the Manufacturer's Alliance, a Washington trade group representing 450 U.S. firms.

Under U.S. law, U.S. firms, such as Eastman Kodak Co. and the Boeing Co., exempt up to 30% of their export income from taxation. Europeans argued that the law represents an illegal subsidy since it gives U.S. companies an edge. The U.S., which frequently argues that foreign countries illegally subsidize their companies, contended the U.S. tax rebates are legal.

After Monday's ruling was announced, EU Trade Commissioner Pascal Lamy said it was "up to the U.S. to comply with the WTO's findings."

In a conciliatory response, U.S. Trade Representative Robert Zoellick said he would "cooperate with the EU in order to manage and resolve this dispute" and would consult with Congress and affected companies about how to respond.

Gary Hufbauer, a trade expert at the Institute for International Economics, said the EU hopes to use the favorable ruling to gain more leverage in the steel dispute and the newly launched global trade talks where its farm policies are under attack.

"They will threaten retaliation in order to get more value for their chips," he said of the EU.

The U.S. and Europe have been fighting over tax policy for decades. The latest chapter can be traced to 1971, when Congress created the Foreign Sales Corporation program so ailing U.S. corporations could keep their overseas profits outside the country and safe from some taxation.

In 1999, the WTO upheld an EU complaint about the FSC program and the U.S. agreed to amend the law. But the Europeans opposed the new version and filed another complaint leading to Monday's decision.

U.S. firms contend that the FSC program puts them on a more equal footing with their European competitors. They claim the EU provides benefits to its exporters in other ways, including a rebate of the value-added tax, a type of consumption tax common in Europe.

Steven Clemons, vice president of the Washington-based New American Foundation, said the WTO ruling places U.S. multinationals in a difficult spot because their insistence on the tax credit threatens the credibility of the global system they championed.

"It's awkward for these companies because they were at the forefront in the fight to create the WTO, and now they are saying this is an unjust dispute," he said.

On Capitol Hill, Monday's decision added another wrinkle to the ongoing debate on tax reform. California Rep. William M. Thomas (R-Bakersfield), chair of the House Ways and Means Committee, has urged the U.S. to adopt a territorial system similar to Europe's, where domestic profits are taxed and foreign earnings are largely off limits. But Sen. Max Baucus (D-Mont.), chair of the Senate Finance Committee, said the U.S. should not cave in to European pressure and should instead push the WTO to "preserve the sovereign right of each country to set its own tax policy."

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