Foreign Sales Corporation (FSC) Tax Benefit for Exporting: WTO Issues and an Economic Analysis

Publication Date: December 2000

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Trade

Type:

Abstract:

The U.S. tax code's Foreign Sales Corporation (FSC) provisions permit firms that sell their exports through qualified sales subsidiaries (FSCs) to exempt somewhere between 15% and 30% of their export income from federal tax. The purpose of the provision is to stimulate U.S. exports.

Economic theory suggests that FSC probably does increase U.S. exports by a very small amount. But beyond this, FSC's other economic effects are probably surprising to many non-economists. First, because of the exchange rate adjustments that FSC triggers, it also increases U.S. imports, so that its effect on the U.S. balance of trade - the value of exports minus the value of imports - is probably negligible. CRS estimates based on 1996 data suggest that FSC increases the quantity of exports by a range of 2-tenths of 1% to 4-tenths of 1%; it increases the quantity of imports by a range of 2-tenths of 1% to 3-tenths of 1%. Based on 1996 trade flows, these estimated changes amounted to $720 million to $1.23 billion of exports and imports alike. Another economic effect of FSC is perhaps more important - a small transfer of economic welfare from the United States abroad that occurs when part of the tax benefit is passed on to foreign consumers as reduced prices for U.S. goods.

FSC is the statutory descendent of the Domestic International Sales Corporation (DISC) provisions, enacted in 1971; DISC delivered a tax benefit of the same general size as FSC. However, several U.S. trading partners charged that DISC was an export subsidy in violation of the General Agreement on Tariffs and Trade (GATT). FSC was enacted in 1984 as a replacement for DISC that was designed to be GATTlegal. Recently, however, the European Union (EU) has charged that FSC itself contravenes GATT's successor - the World Trade Organization (WTO) agreements - and filed a complaint with the WTO. In October 1999, a WTO panel supported the EU. Under WTO procedures FSC must be brought into WTO compliance by November 2000. Absent compliance, the EU could request compensation from the United States or ask the WTO to authorize retaliatory measures.

In November, 2000, Congress passed (and the President signed) legislation designed to replace FSC with a WTO-compatible export tax benefit. The legislation provides a tax benefit for exports of the same general magnitude as FSC, but its statutory mechanics differ--qualifying exports, for example, need not be sold through a subsidiary corporation, and a matching amount of income from foreign operations would potentially qualify for the tax benefit. The EU has stated it does not believe the new tax benefit to be WTO-compliant. It has asked the WTO to rule on whether the replacement provisions are WTO-compliant, and, if they are not, to authorize retaliatory tariffs. This report will not be updated.