TCS Daily

Pro-Growth or Pro-Pork?

By Kevin Hassett - October 22, 2004 12:00 AM

There have hardly ever been tax bills in Congress that received press as bad as the latest international tax bill. The New York Times wrote that this bill "gave something to almost everyone." The Washington Post noted that the bill "doles out scores of tax breaks for interests ranging from tackle box makers to Native Alaskan whaling captains."

What happened to normally prudent Ways and Means Committee chairman Bill Thomas? Was he captured by K Street? One thing that might make one suspicious that the public picture is less than complete is the peculiar set of circumstances associated with this bill. International tax is one of the most confusing areas in all of tax policy, and it is possible that interesting substance could be missed by journalists who do not cover the area full time. When we pass an income tax bill, there are always (regrettably) "rifle-shot" amendments that reward special interests, but income taxes are so easy to understand that they get the headlines. On this bill, it is very hard to cover the substance, so the rifle shots get all of the press.

The bill is quite long, with over twelve hundred pages of law and explanation. And, it has zillions of provisions, with some sounding quite mysterious like "Disregard unexercised powers of appointment in determining potential current beneficiaries of ESBT."

But the economic core of the bill is less mysterious. It consists of three pieces. First, the repeal of an export-related tax provision called FSC/ETI that is incurring 12% tariffs by the European Union for our failure to comply with our World Trade Organization (WTO) obligations. Second, technical tax changes that affect U.S. multinational corporations. Third, a reduction in the corporate tax rate for manufacturing activity. The fourth piece -- most euphemistically described as "other" -- is by far the most discussed.

Let's have a look at the other three parts. Repeal of FSC/ETI alone is a notable victory for the U.S. economy. Tariffs against U.S. exports started last March and were scheduled to rise to 17 percent by early next spring. Tariffs are a bad thing, and leaving them in place would undoubtedly harm U.S. exporters. However, the repeal of this provision, while relieving those being punished by the EU with tariffs does amount to a tax hike on many U.S. multinationals.

From the beginning of this process, technicians at the Ways and Means Committee set out to use that money to make some rather not-so-sexy reforms in the corporate tax code. The international tax code is a complicated mess, with compliance costs that are ridiculously large relative to the amount of revenue raised. Technical fixes that reduce those costs were part of the bill from the outset. All of the newsworthy stuff came later.

There are over twenty significant but technical provisions in this bill in the arena of international taxation, and you might never come to TCS ever again if I tried to explain all of them. But my sense is that there is a broad consensus among tax practitioners that many of these provisions are significant improvements relative to current law. For example, under current law, foreign-sourced income is allowed a "tax credit" for taxes paid abroad. When a company earns $100 in the U.K. and pays $30 in taxes in overseas, their U.S. tax obligation is reduced by $30. Without this credit, there would be a double tax, and total tax rates on foreign income could reach over 70 percent.

But double taxation was not always eliminated under the old law, indeed the tax credit expired after five years. As a result, many firms were left either unable to use these credits or were forced to pay consultants millions to juggle their income activity in order to avoid double taxation. Now firms are allowed to use their foreign tax credits anytime in a 10 year window. That will significantly reduce the problem of expiring credits, and reduce the need for juggling activity.

The bill also contains a reduction in the U.S. corporate tax rate for U.S. manufacturers. As my colleague Eric Engen and I have previously documented, the U.S. corporate tax rate is among the highest in the world, and this encourages income flow away from the U.S.. The correct policy response is to lower the corporate tax rate for everyone across all industries. Advocates of the manufacturing break say that moving manufacturing's rate now will make lowering the rate for everyone else easier. That may be, but there is a risk that different rates across industries will cause some distortion in the interim. But lower tax rates for manufacturing will doubtless improve competitiveness.

The final section of the bill is all of the measures that have been treated as legislative candy. Closer inspection, however, reveals that even these smaller provisions are often sensible policies. For example, one provision called for the "temporary suspension of custom duties on certain ceiling fans." I asked around about why this was in there. It turns out that we had protectionist duties protecting U.S. ceiling fan manufacturers. Removing these is sound economics. Looking through the list, fairly often it is the case that the microprovisions actually made similar sense, and could be thought of as housecleaning.

On balance, then, this bill is likely not much different from most others. It contains anchor provisions that are very good policy. As is almost always the case, getting the good law passed required mixing in pork as well. This time around, however, the pork got more of the attention because the good stuff is so hard to understand.


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