Posted on 23-9-2002

A Civil War Within a Trade Dispute
By Edmund L. Andrews, NYT, 19 Sept02

What began as an obscure trade dispute between Europe and the United States
has turned into a political brawl over $100 billion in corporate tax breaks
that pits many of America's biggest companies against one another.

In the behind-the-scenes lobbying battle, Boeing is lining up against
General Motors, Walt Disney against AOL Time Warner, Caterpillar against
Deere, and Microsoft against I.B.M. Business interests are so divided and
the corporate intrigue so intense that Congress has become all but
paralyzed over the issue. Indeed, many of Washington's high-priced tax
lobbyists have clients on both sides of the fight. The consequences of
stalemate, however, could be severe. The World Trade Organization has
repeatedly ruled that an American tax break for what are known as foreign
sales corporations amounts to an illegal trade subsidy.

The arrangement provides a huge benefit to many multinationals by allowing
American companies to reduce their taxes on profits from exports by
channeling sales through a foreign sales corporation, based in a low-tax
country. Boeing saves more than $100 million a year with it. Eastman Kodak
saves about $40 million a year. But if the United States refuses to
eliminate or fundamentally change the break, it could ignite a
trans-Atlantic trade war. The European Union is entitled to impose up to $4
billion in retaliatory tariffs on American exports — a reprisal far bigger
than any the W.T.O. has ever approved.

Democrats and Republicans both want to come up with an arrangement that
repeals the old tax break and replaces it with a new one of roughly the
same size. Despite repeated attempts, however, no one has yet devised a fix
that does not hurt somebody, and almost every potential loser wields
considerable influence in Congress. "These guys can calculate down to the
dime how much the F.S.C. or any other tax benefit will bring them," said
Bill Reinsch, president of the National Foreign Trade Council, an industry
lobbying group whose own members are torn over the issue. "You don't have
much discussion about what makes good tax policy. You have a discussion
about how it affects each company's bottom line."

The only specific proposal to fix the mess has thus far come from
Representative Bill Thomas, Republican of California and chairman of the
House Ways and Means Committee. His bill would rearrange about $95 billion
in corporate tax breaks over the next 10 years, eliminating about $51
billion tied to the export subsidy and replacing it with others that lower
taxes for companies that have big operations overseas.

The problem is that the new tax breaks would benefit very different
companies than the old ones did. The current beneficiaries are mostly big
exporters, among them Boeing, Caterpillar, Microsoft, Walt Disney and
Eastman Kodak. The new winners would primarily be American multinationals
with extensive factories or services overseas, including General Motors,
Coca-Cola, Procter & Gamble, Dow Chemical, Wal-Mart Stores, AOL Time Warner
and I.B.M.

European leaders have said they will give the United States time to change
its law, but last week they published a huge list of products that could be
hit with new tariffs, from Califonia raisins and Florida citrus fruits to
Kellogg cereal and Levi's jeans. "There was a lot of hope that this would
go away," Mr. Thomas said. "We now know the hard, cold facts." The "hard,
cold facts" involve more than just taxes. American lawmakers and corporate
executives have also been forced to face the reality that an outside
institution like the W.T.O. has the power to demand that the United States
change its own laws.

The crux of the problem is a tax break that was originally intended to
compensate for a basic difference between American and European tax law.
The United States imposes taxes on a worldwide basis, taxing profits of
American corporations regardless of where the money is earned. European
countries follow a "territorial" system that does not tax foreign earnings.
On top of that, European countries effectively exempt exports from the
value-added tax that is imposed on most domestic sales.

For years, European and American leaders followed a gentleman's agreement
not to challenge each other's tax breaks. But the gentlemen's agreement
broke down in 1994, when the European Commission attacked the American tax
loophole and took its case to the newly formed W.T.O.

To the surprise of American trade officials, the trade body unequivocally
agreed with the Europeans. It cited international trade treaties that
categorized any "export contingent" tax break as an unfair and illegal
export subsidy.

When Congress passed a new version of the same law, replacing the "foreign
sales corporation" with "extraterritorial investment," the tribunal struck
that down as a mere fig leaf. Tax and trade experts say there simply is no
tidy solution that will comply with the W.T.O. and not require big changes
in the tax code. "You cannot replace this with anything that is
`export-contingent,' " said John Meaghar, a tax and trade lawyer at the
Federal Policy Group. By definition, that makes it almost impossible to
replace tax breaks that were created explicitly for exporters. "It's like
trying to place a round peg in a square hole," Mr. Meaghar said.

As soon as Mr. Thomas made his proposal to shift the tax breaks over the
next decade, companies pounced on it. "As we look at the bill, the export
of U.S. commercial aircraft would become considerably more expensive," said
Rudy de Leon, Boeing's vice president in charge of Washington affairs.
Chris Padilla, Kodak's top lobbyist on the issue, initially denounced the
bill as the "make film in China" act. Last week, Mr. Padilla said Kodak had
found more potential benefits in the Thomas bill but remained wary. "The
question is, how do you find a way to come out at the end of this to
improve the competitiveness of American companies without creating massive
tax incentives to go off-shore," he said.

Democratic lawmakers on the House tax-writing committee have also pushed
the complaint that Mr. Thomas's bill would encourage companies to send jobs
overseas. "If we are giving tax relief to American corporations, it's
ironic that the relief is going to corporations that have already decided
to leave America for tax purposes," said Representative Charles B. Rangel,
the ranking Democrat on the Ways and Means Committee.

But leading Republicans on the committee are also opposed. Among them are
Jennifer Dunn of Washington, whose state is home to both Boeing and
Microsoft; Philip Crane of Illinois, whose district is home to Caterpillar
and includes big operations of Boeing; and Sam Johnson of Texas, whose
district includes military contractors. "This bill imposes tax burdens on
some of the companies that have been doing business abroad big time,"
Representative Crane said. "There is an enormous incentive for companies to
leave the States."

In an effort to broaden the appeal of his bill, Mr. Thomas included
provisions that would clamp down on companies that try to escape federal
taxes by reincorporating in tax havens like Bermuda. That provision helped
garner the support of at least one Republican on the tax committee, Nancy
L. Johnson of Connecticut. Ms. Johnson's district is home to Stanley Works,
which provoked intense local anger by announcing plans, since withdrawn, to
establish an official headquarters in Bermuda. But that same provision
angered another Republican, Kevin Brady of Texas, whose district includes
several oil-service companies that complained loudly about having their own
tax moves derailed.

Yet another source of Republican opposition comes from scores of American
subsidiaries of foreign corporations, from DaimlerChrysler and Siemens to
Nokia, the Finnish mobile telephone manufacturer.

Foreign companies bitterly complain that they would be badly hurt by a
provision that is supposed to penalize companies that try to avoid United
States taxes by making interest payments to their foreign parents. John
Engler, the Republican governor of Michigan, which is home to the Chrysler
subsidiary of DaimlerChrysler, complained that the bill would "undermine
economic development incentives" and drive existing businesses out of the
state.

Senator Max Baucus, Democrat of Montana, has teamed up with Senator Charles
Grassley, Republican of Iowa, to look for a bipartisan solution. But the
issue does not really cut along party lines and influential lawmakers
confess they are stymied.

Mr. Rangel, the leading Democratic critic of the Thomas bill, said that he
did not have any better solution to the riddle. "I don't know," he
admitted. "I don't feel awkward in saying I don't have the answer yet."