Retirement and Social Security Reform
End This Damaging Tax and Trade Charade
March 09, 2004
By Ernest Christian and Gary Hufbauer
US Congress is about to increase the tax burden on exports
of American-made goods and services. Why? Because the World
Trade Organisation says it must. To avoid a trade war, Congress
will probably go ahead and repeal the Foreign Sales Corporation,
a tax relief device that has been used in one form or another
for 30 years. But when Congress does repeal FSC, it should
call a halt to the charade that forces the US to tax its exports,
while allowing other countries not only to exempt exports
from value-added tax but also to impose VAT on imports from
The WTO says this huge distortion of free trade - a net disadvantage
for US exporters of more than $100bn annually - is justified
because our corporate income tax is a "direct" tax,
whereas tax on value added is an "indirect" tax.
That distinction is a pernicious fiction, created and perpetuated
by trade mandarins, that has no place in either logic or fact
and no place in America's trade relations. Enough is enough,
and Congress should so declare.
When it repeals FSC, it should also call on the European Union
and all other countries to join the US in correcting the mistaken
distinction between direct and indirect taxes. Congress should
simultaneously urge US trading partners to cease exempting
their exports from VAT and cease imposing those taxes on imports.
If they do not amend their tax practices within a decent period,
the US tax code should at least be amended to exclude export
income from US corporate income tax and allow American-made
goods and services a fair opportunity to compete in world
The mistaken distinction between direct and indirect taxes
dates from the late 1960s, when the French were converting
their old "cascade" taxes on gross business receipts
to new taxes on net business income that later came to be
called value-added taxes. The French desperately wanted to
exempt exports from VAT and impose it on imports, so their
trade mandarins pretended that VAT was an indirect tax, like
the duty on whisky. Our trade mandarins acquiesced, because
that was the era of European reconstruction and dollar shortages.
All the US asked was leeway to reduce the corporate tax on
exports, a request that was consistently denied by the EU,
the General Agreement on Tariffs and Trade and its successor,
the WTO. Today, the pretence is all that remains - and the
enormous artificial trade advantage enjoyed by the EU and
For more than three decades, Congress has laboured under the
false impression that basic principles of international law
and economics having to do with direct and indirect taxes
require the US to tax its exports in full - unless it joins
other industrial countries and adopts a VAT system. Deep political
misconceptions have made it impossible for Congress to consider
the merits of value-added taxation. The EU and others, as
part of a prolonged game of "Gotcha", have insisted
that the only way the US can ever exempt its exports from
tax is to adopt the European tax system. Who can blame the
Europeans? In 1970, they pulled off one of the biggest trade
heists in history and they want to keep their multi-billion-dollar
advantage - even though it is based on a false premise.
The false premise is the assumption that the economic burden
of the VAT falls totally and uniformly on the purchasers of
goods and services (like an excise tax on whisky), whereas
the economic burden of the US corporate income tax falls totally
and uniformly on the producers of goods and services (like
a tax on property). But the predominant view today is that,
in the absence of tax adjustments at the border, the economic
burden of both corporate income tax and VAT falls primarily
on the labour and capital that produce goods and services.
In this sense, both taxes are direct taxes.
Whatever may have caused past presidents and Congresses to
accept the false distinction between direct and indirect taxes,
this Congress and this president should re-examine the issue
as they repeal FSC, and think about what comes next. There
is a compelling need for a coherent policy on the role that
taxes play in distorting free trade. The stakes are high,
payable in US jobs in sectors that make traded goods and services.
In a global trading system free of distortions, US jobs lost
to foreign competition are usually replaced by even better
ones. But when US jobs go overseas because of tax distortions,
something is badly wrong.
Ernest Christian, a former Treasury tax official, is co-director
of the US Export Coalition. Gary Hufbauer, a former Treasury
tax official and an architect of the FSC legislation, is senior
fellow at the Institute for International Economics.