News Release

January 17, 2002

WTO Rules Against U.S. Tax Break, Opens Door for Business Tax Reform

WASHINGTON—The World Trade Organization (WTO) ruled Monday that the U.S. tax treatment of Foreign Sales Corporations (FSCs) is an "unfair trade subsidy," siding with the European Union on the issue. The $4 billion FSC tax break was designed to help U.S. companies compete in foreign markets. On the other hand, Cato scholars Veronique de Rugy and Chris Edwards note that the federal tax code penalizes U.S. firms in many ways, so a good policy response to the WTO ruling would be to remove both the tax subsidies and penalties on U.S. businesses.

Fiscal policy analyst de Rugy notes that:

"The United States could simply eliminate the FSC tax break, but that would mean a $4 billion tax increase on America's exporting companies. Alternately, the U.S. could ignore the WTO ruling, but the cost could be huge since Europe would be able to impose $4 billion of compensatory tariffs against U.S. products.

"Instead, the best option is to repeal the tax subsidy, but also eliminate the tax disadvantages that U.S. companies face competing in world markets."

Chris Edwards, director of fiscal policy, recently calculated that the average corporate tax rate in 26 major industrial countries is now 31 percent – 4 percentage points lower than the U.S. rate of 35 percent. "For businesses, the U.S. is a high-tax country, and we should not have a higher corporate tax rate than countries such as Britain and Sweden," said Edwards.

De Rugy pointed out another penalty faced by U.S. companies:

"For years, the federal government has expanded the taxation of U.S. firms' foreign income, leading to higher tax rates on international investment than imposed by other major countries. Switching to a territorial tax system, as under proposals such as the flat tax, would solve this problem and remove barriers for U.S. companies competing for markets abroad.

"Let's turn this WTO ruling to the advantage of the U.S. economy. We should eliminate the subsidy, but also cut the corporate tax rate and move to a territorial tax system. That way, U.S. companies can compete in world markets without being penalized."