The Cutting Edge — September 2003

Public Policy

By John Satagaj, WMMA Legislative Counsel (email@jsatlaw.com)

Several years ago, the European Union (EU) challenged a long time United States tax program as a subsidy that violated World Trade Organization (WTO) rules. The program was the Foreign Sales Corporation (FSC) that provided tax relief for certain foreign sales that included foreign based content. The WTO ruled the program was indeed a subsidy. In 2000, the Congress crafted another program, the Extraterritorial Income (ETI) program to achieve the same goal without violating WTO rules. However, the EU challenged it, the WTO agreed with the European Union, the U.S. appealed, and the WTO appeal body upheld the decision the ETI program is an illegal subsidy. The WTO ruled the EU was entitled to impose $4 billion in trade sanctions against the U.S. The EU then published a very long proposed list of goods upon which it might impose retaliatory tariffs. Some 3,000 products are on the list and the potential tariffs amount to over $15 billion. While the EU has published a list, the tariffs were not imposed immediately. The EU has since reduced the list to match the magnitude of the sanctions.

Publication of the list was the next step in the traditional saber rattling each side engages in to force the other to take some action. In this case, the idea was to put pressure on the U.S. Congress to repeal the ETI program. I guess it worked because members of the Senate Finance Committee, House Ways and Means Committee and the Administration see resolving the ETI dilemma as a major priority.

This is where the plot takes an interesting twist.

Prior to the August recess, the House Ways and Means Chairman Bill Thomas (R-CA) released his proposal, H.R. 2896, "The American Jobs Creation Act of 2003," to repeal the ETI program and replace it with a variety of tax relief provisions for businesses. A competing proposal has been introduced by Representatives Phil Crane (R-IL), Charles Rangel (D-NY) and Don Manzullo (R-IL). H.R. 1789, the "Job Protection Act of 2003," would also repeal the ETI program but replace it with a different set of tax relief items.

Unlike the ETI and FSC tax relief regimes, the new proposals offer a mix of targeted relief along with tax relief for all manufacturers. As a result, the proposals have sparked a lively debate on who should reap the benefits of the new relief. The proposals range from corporate rate relief to additional depreciation incentives.

Among the items in the Thomas bill are a new reduced 32 percent top tax rate for corporations with less than $10 million of taxable income; reduced depreciable lives of manufacturing equipment that is used in the United States (10 year lives reduced to 7 years, 7 year lives reduced to 5 years, and 5 year lives reduced to 3 years); extension for one year (through December 31, 2005) of the 50 percent bonus depreciation provision contained in this year's "growth" law; and extension for two years (through December 31, 2007) of the Section 179 increases in this year's "growth" law. (Direct expensing limit was increased from $25,000 to $100,000 and the capital expenditure cap was doubled from $200,000 to $400,000.).

Under the Crane/Rangel/Manzullo bill, a manufacturer's 35-percent corporate income tax rate effectively drops to 31.5 percent if its products are produced solely in the United States. Other companies would receive a sliding-scale effective rate reduction based on the value of their U.S. production of eligible products compared to the value of their worldwide production.

Senator Charles Grassley (R-IA), chairman of the Senate Finance Committee, and Senator Max Baucus (D-MT), ranking member of the committee, are expected to release their own proposal in September.

The tax revenue "gained" by repealing the ETI/FSC regime is $50 billion over 10 years. The Crane/Rangel replaces it with roughly the same amount of tax relief. The Thomas bill is estimated to "cost" as much as $120 billion over ten years so the additional relief beyond what can be paid for by repealing the ETI/FSC must be made up a different way.

We believe Congress will act on some sort of ETI/FSC repeal this year. We expect the magnitude of the new tax relief to be in the $50 billion to $70 billion range over 10 years. Finally, we do expect you and/or your customers will derive some benefit as we believe at least some of the new tax relief will be available to most manufacturers. We are not as confident in our ability to predict whether it will be rate reduction relief as in the Crane/Rangel/Manzullo plan or deduction/credit relief (depreciation, R&D, AMT, etc.) as in the Thomas plan.

For last month’s article, click here.