September 27, 1999

Review & Outlook

Tax and Trade

When is a "subsidy" not a subsidy? When it's a tax break, for one. But politicians who have grown attached to the assumption that government has a legitimate claim on all income--look at how the World Wide Web is fighting them off--have trouble getting that straight.

People who believe that somebody has to "pay" for tax cuts and that capital gains tax reductions are "giveaways" to the rich will quite naturally conclude that tax cuts for corporations are "giveaways" as well. Such, at least, was the logic behind the European Commission's complaint that sections of the U.S. tax code granting special treatment to so-called Foreign Sales Corporations constitute illegal "subsidies" under the rules of the World Trade Organization. The WTO has apparently agreed, and, in a ruling that has yet to be made public, has given the U.S. 12 months to rewrite the code.

In some respects, the EU and WTO have a point. The Foreign Sales Corporations scheme, which gives tax relief to American companies exporting through offshore subsidiaries in places like the Virgin Islands, Barbados and Guam, provides tax relief that the EU estimates at $2.5 billion annually on $250 billion worth of exports. It is also a fairly blatant attempt to favor domestic industry by, for example, limiting the tax breaks to goods having at least 50% U.S. origin by market value. That's a clear violation of at least the spirit of the WTO rules, which forbid "subsidies contingent . . . upon the use of domestic over imported goods." We have no problem with the complaint against this practice and look forward to the Europeans carrying the flag against domestic content preferences.

Trouble is, WTO rules don't seem very clear on whether tax breaks (which in this case clearly are "contingent") constitute subsidies in the first place. A subsidy, they say, shall be deemed to exist when "government revenue that is otherwise due, is foregone or not collected." But what is meant by "otherwise due"?

The answer to that question is of more than semantic importance, since complaints about "unfair tax competition"-and attempts to use multilateral bodies to stamp it out-are increasingly common, especially from the bloated welfare states of the EU. Indeed, the EU has already undertaken to "harmonize" some tax rates (VAT, for example) in an attempt to prevent "fiscal dumping," and would like to harmonize others if not for the objections of more lightly taxed members. Ireland, for one, has already gotten into trouble with the European Commission over complaints that its low corporate tax rate is an unfair "subsidy."

Tax competition between states is a good thing. The power of individuals and companies to vote with their feet is one of the most potent weapons against overweening government. Any attempt to deprive them of places to run must surely be considered an attack on freedom and a threat to prosperity. There is all the difference in the world, moreover, between giving people something they never earned and not taking what they have earned.

The WTO, which has done so much to open world markets, may have very good reasons for its decision in this case. But let's hope that when the text of the ruling is finally released, it will not signal too much sympathy for the notion that tax cuts are subsidies. Competition, after all, is what the WTO was set up to promote, wasn't it?

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