WTO Unfair to US Exports
by Fred E. Foldvary, Senior Editor
The World Trade Organization, the international organization that governs trade among countries, ruled on August 29, 2002, that the United States of America may not provide tax credits for its exports. Like all governments, the US imposes taxes that increase the cost of production and make its exports more expensive. That reduces exports. A tax credit on exported goods removes the added cost and trade barrier imposed by taxes. The WTO ruling forces the US to keep that added cost, contrary to the WTO mission to reduce trade barriers!
It would not be so bad if all countries had to keep the costs added by taxation to exports. But those countries that use a value added tax (VAT) are allowed to exempt exports from the tax. The VAT is a tax on the value added by a firm's production. For example, suppose a company makes furniture. It hires labor, rents real estate, and buys wood, cloth, and nails. The furniture it produces has more economic value than the cost of the labor, real estate, and materials. The VAT is a tax based on that added value.
If, say, the inputs cost $1 million and the output would sell for $1.5 million without taxes, the value added is half a million dollars, and a 50% VAT would be a quarter million dollars. The furniture then sells for $1.75 million with taxes. But if the furniture is exported, there is no VAT. It exports at $1.5 million.
The USA does not have a VAT. The federal government imposes taxes on income, including business profits. It is not feasible to exempt an exporter from income taxes, but it is possible to just provide a tax credit for the exported goods. That is what the US did, and what the WTO has ruled to be against WTO rules. This ruling discriminates against countries with income taxes and in favor of countries with value-added taxes.
The European Union (EU) complained that it was being hurt by the US tax credits. The World Trade Organization decreed that the European Union could slap penalties of $4 billion on U.S. exports as a penalty for allegedly "illegal" subsidies. But these are not really subsidies. The credit are the removal of taxes, just as the European countries do with their VAT.
EU officials will not impose the penalty immediately, but give Congress time to change the tax law. The removal of the tax credits will hurt US exports and make the US trade deficit even larger. Many thousands of American jobs will be lost.
The US should challenge the WTO policy that lets countries with VAT exempt exports. But more fundamentally, the US tax laws are to blame. Goods manufactured in California are exported to New York just as they are to Japan. Why should exports to Japan be favored over exports to New York? The export tax credits were needed because taxes artificially increased the cost. The sensible policy would be to eliminate this tax cost for all goods and places.
As Henry George wrote in his book Protection or Free Trade?, true free trade means the elimination of all trade barriers, both foreign and domestic. The complete elimination of income taxes would make it unnecessary to provide tax credits for exports.
It is not politically realistic to expect that the abolition of federal and state income taxes would be matched immediately with the elimination of that amount of government spending. But the elimination of the excess burden and added costs of taxation could be accomplished by shifting taxes from income to land rent or land value. Since the land is already here and has no cost of production, taxing land value does not increase the rent or the cost of production. The rent just gets shifted from going to the landlord to going to the government.
This radical change in public finance would meet fierce political resistance, so there is another way to eliminate the federal excess tax burden. Divide the US federal budget by the total land value in the US, and then require each State to pay its share of the budget in proportion to its share of land value. Since State income taxes are mostly based on the federal tax, many states would eliminate their income taxes too.
This proposal is nothing new, and in fact, this was to be the tax system of the United States when they became independent in 1776. The Articles of Confederation enacted this very system. The US Constitution overturned land-value taxation when it was adopted in 1787, although it retained it in part by allowing "direct" federal taxes on real estate. The last federal tax on real estate was attempted in 1861, during the Civil War. A problem was that the Constitution required the direct tax to be apportioned by population. But the 16th Amendment did away with that requirement. So the US government could tax land value if Congress wanted to.
Either way, by taxing land value or having the States pay it according to land value, the shift in taxes would not just eliminate the added cost for exports, but the added cost for all goods, and this would also let workers keep their full earnings if sales taxes were also eliminated.
Meanwhile, since such major reforms will take time, if the WTO does not treat VAT and income taxes equally for exports, the US should quit the WTO and create an alternative organization for global free trade that seeks to eliminate all trade barriers, and does not interfere with governments that attempt to reduce the trade barrier caused by taxation.
-- Fred Foldvary
Copyright 2002 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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