In today’s globally competitive world, companies from countries everywhere are significantly impacted by national tax laws and subsidies. As a result, it is vital to keep abreast of changes — especially since tax laws and subsidies often evolve and become extremely complex, resulting in numerous unintended consequences.

In many ways, this is what is happening to both tax codes and subsidies in the U.S. and the European Union (EU). But today, the unintended consequences could be detrimental to thousands of U.S. companies.

Attempts To Level the Playing Field Fail

As a result of what many consider an unfair EU tax advantage, thousands of U.S. companies could be put at a competitive disadvantage at a time when the U.S. economic recovery appears uncertain. How did we get here?

Today’s situation certainly isn’t unrelated to the past. For decades, EU industries, such as aerospace and telecommunications, have been subsidized. This has boosted their international strength or shielded them from global competition. In addition, the EU has exempted and continues to exempt its exporters from paying a value added tax. In effect, this has significantly reduced their tax burden.

To counter what many U.S. companies felt was an unlevel playing field more than two decades ago, the U.S. crafted the Foreign Sales Corporation (FSC) tax code in 1984. This was designed to help U.S. exporters compete more fairly with EU companies, as well as others around the world. Many U.S. companies claim it was a success. In fact, a National Foreign Trade Council report states that 3.5 million U.S. export-related jobs benefited from FSC tax incentives in 1999.

However, the EU challenged the FSC rule through the World Trade Organization (WTO), and won in 2000. To appease the EU and global trade body, the U.S. repealed the law. In its place, the U.S. Congress created the Extraterritorial Income Exclusion (ETI) Act of 2000. But the new law still didn’t satisfy the EU. Consequently, the group of 15 European countries challenged it through the WTO, and won.

As a result, the EU has been authorized to impose sanctions of more than $4 billion annually on U.S. exports, which include steel, beef, sugar, wood and paper products, cotton, apparel, cosmetics, and electrical machinery.

Creating Artificial Winners and Losers

Although Europe’s tax loopholes and subsidies distort trade by artificially increasing the attractiveness of its goods and services on world markets, its indirect tax system is technically WTO-compliant. WTO language doesn’t cover indirect taxes, only direct taxes like those used in the U.S.

So, what can the U.S. do? If ETI is removed without Congress establishing a suitable replacement, approximately 6,000 U.S. exporters who rely on ETI to compete could be hurt. Many of these firms are small and medium-sized, but they are not the only ones that stand to lose. Large companies will be impacted too.

Boeing, for example, estimates that repealing ETI will result in the loss of nearly 10,000 of its high-tech jobs, as well as 23,000 more jobs with its suppliers. Why? Boeing’s heavily subsidized European rival, Airbus, is estimated to have received more than $30 billion in EU financial support. Boeing claims this has given the EU conglomerate an unfair advantage. Furthermore, analysts believe this has affected the entire U.S. aerospace industry that employs nearly 800,000 highly-skilled workers.

There is no doubt that multiple layers of loopholes and convoluted subsidies artificially create winners and losers in international trade. But what approach will be fair to both U.S. and European companies?

The Devil Is in the Details

The U.S. response to the ETI challenge is currently being debated in Congress. But one thing remains certain: a growing number of U.S. Congressional Representatives believe U.S. exporters need a mechanism that counters their EU rivals’ government tax incentives and subsidies. Congress also must understand that it needs to act quickly. If WTO concerns are not satisfied soon, the EU likely will implement $4 billion worth of trade sanctions against U.S. exports, a move that could start a transatlantic trade war.

If Congress scraps the current ETI program and creates a new export tax incentive, a very likely scenario, the changes in tax codes will benefit some firms, but put others at a competitive disadvantage — in both the United States and around the world. As a result, it is important to follow Congressional action over ETI and understand how changes in the law may affect your business.

This article appeared in December 2002. (BA)

John Manzella
About The Author John Manzella [Full Bio]
John Manzella is a world-recognized author and speaker on global business, emerging risks, competitive strategies and the latest economic trends. He also is founder of the and Chief Strategy Officer of Ignition Life Solutions. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.

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