The Wall Street Journal
By Keith Marsden, an economist based in Geneva.
The World Trade Organization badly needs to refurbish its image after last year's debacle in Seattle, and to demonstrate its continuing relevance as an independent arbitrator of rules that promote global trade, free markets and open competition. Stamping out tax breaks is not a good place to start.
Thursday an appellate panel is expected to support an earlier WTO dispute settlement panel that backed an EU complaint against the U.S. Foreign Sales Corporation tax scheme. The FSC provides tax incentives designed to boost exports from U.S. corporations established in Caribbean and Pacific island countries. The EU argues that the FSC scheme allows U.S. exporters to avoid billions of dollars in taxes by channeling income through offshore havens, and constitutes an export subsidy that contravenes WTO rules. The U.S. maintains that the FSC helps to create jobs and raise incomes in poor countries, and that FSC tax concessions are only equivalent to the rebates on value-added tax that EU exporters receive. The U.S. can also point out that the EU spends many more billions of euros on subsidies to its industries to limit import penetration.
Last year the U.S. imposed $308 million worth of sanctions on EU exports after it failed to comply with WTO rulings against its ban on hormone-treated beef and its banana regime. This EU challenge to the FSC scheme, after 16 years of operation, is seen by some observers as a tit-for-tat retaliation. It was set in motion by Sir Leon Brittan, then the EU's trade commissioner, who seemed determined to get even. U.S. Deputy Treasury Secretary Stuart Eizenstat has warned that this risks provoking "the mother of all trade disputes." The original WTO panel insisted that the FSC legislation be repealed or amended before Oct. 1 of this year. If upheld by the appellate body, this deadline is unlikely to be met. It falls shortly before the U.S. elections, and any change will be fiercely resisted in Congress.
Tax Competition
Who is responsible for such counterproductive disputes? The main culprits, I suggest, are over-zealous trade lawyers egged on by protectionist governments who want to prop up their own industries and fail to recognize the economic gains that can accrue from open competition between countries, including tax competition.
For many years, international rules sought to eliminate subsidies to enterprises producing traded goods or services on the grounds that they distort trade because they allow the recipients to sell at prices below their costs, thus undercutting more efficient firms. But during the Uruguay Round of trade negotiations the fight against subsidies was weakened by the insertion of various loopholes in the GATT/WTO agreements. The revised Agreement on Subsidies and Countervailing Measures declares that certain subsidies are "non-actionable" -- that is, they cannot be subject to challenge or demands for compensation.
Non-actionable subsidies include assistance to "disadvantaged" regions, some assistance for research activities, and assistance to promote adaptation of existing facilities to new environmental requirements. These may be worthwhile goals and activities. But it is not clear why these particular subsidies should be tolerated while firms must pay the full market price for other inputs that affect the competitiveness of their products and services. All cash subsidies, however earmarked, are fungible. They release resources that can be used for other purposes and allow the recipients to undercut their less-advantaged foreign competitors.
But perhaps more damaging to the open trading system was the decision to include tax incentives within the definition of a subsidy. The Agreement on Subsidies states that "a subsidy shall be deemed to exist if: … government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits)." This implies that a given level or rate of tax, once set by a government, becomes a fixed cost for the enterprise or individual affected, and that any subsequent lowering of the rate, its removal, or any exemptions given, are the same as cash transfers from the government. This stretches semantics too far. It's up to individual governments (and their electorates) to decide what is "otherwise due," and this should be able to be changed at any time.
The purposes of taxes are to fund government services and perhaps redistribute income. If governments, with the support of their citizens, choose to provide fewer public services or indulge in less redistribution, and return the savings to taxpayers in the form of tax credits or reduced rates, they should be entitled to do so without being accused of fiscal dumping or unfair trade practices. The WTO agreement does offer one escape clause. It states that "it is understood that the setting or change of generally applicable tax rates by all levels of government entitled to do so shall not be deemed to be a specific subsidy for the purposes of this Agreement." But this is both illogical and unduly restrictive. It's tantamount to saying that tax relief for exports is harmful, but the same relief on all domestically manufactured goods is fine, even when they are exported.
Why should a country be required to impose taxes on foreign customers through its exports, either directly or indirectly? More than two centuries ago, the New England colonies objected to taxes levied on their imports by the colonial power, Britain. "No taxation without representation" was their famous cry. Why shouldn't sovereign nations be able to turn this slogan around and tell their foreign customers, in effect: You're not represented in our parliaments and therefore we've put no taxes on our exports to you?
A Successful Strategy
Some of the most successful developing countries -- such as Korea, Malaysia and Mauritius -- first managed to break into world markets for manufactured goods by granting their exporters exemption from most taxes on their inputs and profits. Most of their people are now well above the World Bank's absolute poverty line. This WTO Agreement on Subsidies and Countervailing Measures now bars other countries from following suit. It defines prohibited export subsidies to include "the full or partial exemption, remission, or deferral, specifically related to exports, of direct taxes, or social welfare charges paid or payable by industrial or commercial enterprises." It goes on to spell out that "the term direct taxes shall mean taxes on wages, profits, interests, rents, royalties, and all other forms of income, and taxes on the ownership of real property."
Why any developing country should want to impose all these taxes on its entrepreneurs, especially those with the courage to venture forth into foreign markets, is a mystery. Countries should be allowed to decide for themselves whether the jobs and incomes generated by exports are sufficient, without government taking its pound of flesh directly. Additional revenue could still be generated by taxing the consumption of those employed (perhaps for the first time) in export industries, and on these industries' sales in domestic markets.
Developed countries should also be permitted to offer tax incentives to their own investors to encourage them to establish plants or export marketing operations in poorer countries. Tax revenue foregone in this way could make a more productive contribution to third world development than tax dollars spent on foreign aid programs channeled through inefficient and corrupt governments. It would help to create market networks and forge alliances between developed and developing country entrepreneurs that would strengthen their competitiveness.
These issues should be addressed once a new round of trade negotiations gets underway. Encouragingly, the WTO secretariat has already expressed doubts about rules that hinder tax competition and encourage the formation of tax cartels among governments. Its 1998 annual report stated arguments against tax competition "should be treated with considerable caution, as a fight against a 'race to the bottom' in tax rates may be used as a pretext for introducing a tax cartel." Just before leaving office, former Bundesbank President Hans Tietmeyer stressed that the EU would benefit from greater tax competition. "There must be competition between tax systems… in a way that generally leads to more flexibility." Trade policy makers should heed these wise words.
-- From The Wall Street Journal Europe:
