Congress must act to end EU sanctions

By Dr. Paul Freedenberg Vice President-Government Relations AMT—The Association For Manufacturing Technology

By Dr. Paul Freedenberg
Vice President-Government Relations
AMT—The Association For Manufacturing Technology

Few in the general population have noticed that on March 1 the European Union (EU) fired the first shot in what could prove to be a full-scale trade war between the two largest economic entities in the world. As of that date, a 5% additional tariff was imposed on most U.S. machine tools. Furthermore, these tariffs are scheduled to increase by one percentage point per month until they reach 17%. How we got to this point and what will likely happen next requires a bit of history.

In 1971, to offset the competitive disadvantage U.S. companies felt because of European value-added taxes (VATs), the U.S. Congress enacted Domestic International Sales Corporation (DISC) legislation, which allowed U.S. companies to set up "paper corporations" offshore and run all or most of their U.S. exports through them. Roughly 15% of exports eligible for DISC treatment were excluded from taxable income.

This tax break persisted for almost three decades until the EU filed a complaint with the WTO in 1999, contending that DISCs and their successor tax regimes (Foreign Sales Corporations or FSC) violated WTO rules against conditioning favorable tax treatment of corporate income upon exports. A U.S. appeal against the WTO decision was denied in 2000.

Also, in 2000, Congress replaced the FSC with a similar regime Extraterritorial Income (ETI), under which all exporters subject to U.S. taxation (including foreigners) could exclude approximately 15% of export income from U.S. taxes. In 2001, the WTO ruled that ETI also violated WTO rules and would have to be repealed to avoid EU sanctions. Two years passed with no effective legislative action to replace FSC-ETI with a WTOcompatible tax structure.

In 2003, the WTO approved the imposition of EU sanctions against $4 billion worth of U.S. exports to Europe (the sanctions could be imposed annually) until the FSC-ETI law is repealed.

Under EU pressure, in 2002, Congress started the process of repealing FSC-ETI, understanding that it would result in a $5.6 billion annual tax increase for U.S. exporters. A number of proposals were put forward, including one by House Ways and Means Committee Chairman Bill Thomas (R-CA), to use the additional revenues to reduce taxes on U.S. multi-national corporations. This ran into strong opposition from companies, including AMT members, whose manufacturing facilities are located primarily in America and from foreign investors who have a strong U.S.-manufacturing presence.

AMT began working last year with Senate Finance Committee Chairman Chuck Grassley (R-IA) and Ranking Member Max Baucus (D-MT) to craft a FSC replacement that would provide a solid benefit for companies (domestic and foreign-owned) that manufacture products and provide manufacturing jobs in the U.S. The result of Senators Grassley's and Baucus's bipartisan efforts is currently on the Senate floor, where it is being filibustered because of an irrelevant political dispute between the political parties.

Last year, the Senate Finance Committee, led by Chairman Grassley and Sen. Baucus, approved legislation phasing out — over three years — the FSC/ETI deemed illegal by the WTO and phasing in a permanent three-point rate cut for income derived from domestic manufacturing. The rate cut would be limited by 50% of domestic-manufacturing payroll and temporarily reduced (until 2010) for multi-national companies, which include foreign-owned firms. This manufacturing tax cut would apply to Scorporations and other small businesses.

In the House, virtually all Democrats and about one-third of the Republicans are adamantly opposed to any international-tax reforms that benefit multi-national companies. Currently, it looks as though House Speaker Dennis Hastert (R-IL) and the Republican leadership will rewrite the Thomas Bill to resemble the Senate version so that an acceptable FSC-ETI replacement bill can pass the House and move into conference with the Senate. Until that happens, many in the metalworking industries, including machine tool builders, will continue to suffer the pain and exclusion of EU sanctions on their products.

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