Taxes, Exports, and International Investment: Proposals in the 108th Congress

Publication Date: January 2004

Publisher: Library of Congress. Congressional Research Service

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The 108th Congress is considering a set of alternative tax proposals that could affect how U.S. firms compete in the world economy and how they allocate investment between U.S. and foreign locations. A principal impetus for the bills is a dispute between the United States and the European Union (EU) over the U.S. extraterritorial income (ETI) tax benefit for exporting. The EU has complained that the provision is an export subsidy and thus violates the World Trade Organization (WTO) agreements; a succession of WTO rulings has supported the EU position and the WTO has authorized the EU to impose retaliatory tariffs on U.S. goods. All of the major international tax proposals that have thus far been introduced in the 108th Congress address the dispute by simply repealing the ETI benefit.

The bills differ, however, in how they address the economic impact of ETI's repeal. A proposal contained in H.R. 1769 and S. 970 (the Crane/Rangel/Hollings proposal) would replace ETI with a tax benefit for domestic production, including both export and other types of income. In July 2003, Chairman Thomas of the House Ways and Means Committee proposed H.R. 2896, which would implement tax cuts for investment abroad as well as several benefits for domestic investment. In October, the Ways and Means Committee approved a somewhat modified version of the bill. In the Senate, the Finance Committee on October 1 approved S. 1637, containing an alternative mix of tax cuts for domestic and overseas investment. A number of other proposals have been introduced in the Senate that would each repeal ETI while providing domestic investment incentives that differ in their particulars.

A focus of the debate over the proposals has been their prospective impact on domestic U.S. employment, a focus driven in part by concern over the impact of ETI's repeal on U.S. jobs. Economic analysis indeed suggests that in the short run, repeal of ETI would result in the loss of a certain amount of jobs in the U.S. export sector, although ETI's role in the economy is probably not large. The alternative investment incentives provided by the bills would also likely result in the shift of labor and other resources to sectors that qualify for the benefits, for example, domestic manufacturing. Economic theory, however, also indicates that in the long run the bills' likely impact on the overall level of domestic employment would be minimal; in the long run the economy tends towards full employment and labor released by one sector will be absorbed by other sectors. In analyzing international taxes, traditional economics instead focuses on how taxes affect the location of investment -- on firms' decision of whether to invest at home or abroad -- and on the efficiency and economic welfare effects that follow. Each bill contains both provisions that favor domestic investment and changes that favor foreign locations; each bill essentially pulls the system in different directions at the same time. The net impact of the respective plans is uncertain, although it is likely that none would change the basic nature of the U.S. system in providing a patchwork of incentives and disincentives towards location of investment and in its mix of efficiency effects. This report will be updated as legislative developments occur.