(Archived Content)
FROM THE OFFICE OF PUBLIC AFFAIRS
LS-921Thank you. It is a pleasure to be with you today and to see so many of the people with whom I have worked so closely over the years on a wide range of matters. This Council makes a valuable contribution to the European-American relationship, by keeping its members informed about developments of interest and by representing their views to those who make policy. I have known and respected Will Berry for many years, and we have worked on many issues of importance to our economy and in promoting U.S. exports.
One of the great success stories of the last 50 years has been the relationship between the U.S. and Europe. Our growing bilateral economic relationship is one of the engines of economic growth; our growing institutional links have helped us to work together to address political and economic crises around the world.
The United States and Europe have a long tradition of working together to improve the global economy, ease tension in sensitive regions, and liberalize barriers to trade and investment to the benefit of our economies. The importance of our bilateral relationship cannot be over-emphasized. Nearly 45% of U.S. investment overseas has been in the EU, which also absorbs one-fifth of U.S. exports. For its part, EU investment in the U.S. has doubled in the past 5 years, while its exports to the U.S. have grown by 50%, reflecting a substantial interest in continued close relations with the U.S. business community. With $350 billion in two-way trade and $1.1 trillion in two-way investment, we have much at stake.
Our cooperation extends into the foreign policy realm. Since the December 1995 launch, in which I participated, of the New Transatlantic Agenda-the framework for US-EU cooperation-we have worked together to resolve our differences and cooperate in response to global challenges. We have increased our cooperation in the political and foreign policy arenas where we share many common objectives and interests. We worked together with European nations through NATO in Kosovo and Bosnia; we joined together to rebuild the Balkans through the Stability Pact; and we are cooperating to promote the Middle East peace process and to find solutions to other regional conflicts.
Yet, despite our close relationship, trade disputes remain the thorn in the side of the US-EU relationship. A range of trade disputes-such as beef hormones, bananas and hush kits-has raised tensions on both sides of the Atlantic. And recently, the European Commission's decision to challenge the tax treatment of Foreign Sales Corporations (FSC) and to further contest U.S. efforts to revise its tax legislation to comply with the World Trade Organization's Appellate Body threatens to cloud further the Atlantic relationship.
Much has been said and written about the FSC dispute recently, and I think it may be helpful today to provide a bit of background as to why this tax regime was developed in the first place and how we came to the conflict we face today.
The FSC was designed to emulate certain aspects of territorial tax systems in its treatment of foreign source income. The U.S. employs a residence-based, or worldwide, tax system, whereby income earned by a resident, such as a corporation incorporated in the U.S., is subject to tax. Many European countries use a territorial system, whereby only income earned within the borders of the taxing jurisdiction is subject to tax. It is recognized internationally-and, indeed, has been acknowledged by the EC in the course of the FSC dispute-that the territorial system has a tendency to result in exports being taxed more favorably than comparable domestic transactions. The FSC regime was created to offset, at least partially, this advantage.
As an initial response to this difference, the United States enacted the DISC legislation in 1971, which provided a special tax exemption for exports. The EC successfully challenged the DISC in the GATT. The FSC tax regime was then developed in the 1980s as a GATT-legal alternative to the DISC.
Our effort through the FSC to ensure that U.S. companies are not disadvantaged in the global economy stood without challenge for more than 15 years. Nonetheless, beginning in 1998, the EU successfully challenged the FSC in the WTO, which determined that the current FSC regime constituted an illegal export subsidy. I can say that in two and a half years as Ambassador to the EU, not once did a European company or European business organization or European union official ever complain about any unfair advantage bestowed on U.S. companies from the FSC. Indeed, large European companies, through their American subsidiaries, were major users of the FSC, and many now fear that retaliation could be very damaging to their international trade.
The EU contends that, whereas the WTO found the FSC regime constituted an illegal export subsidy, the European tax system does not provide export subsidies. Yet, the European territorial tax system does encourage companies to set up abroad and sell their goods from there. European firms routinely sell their exports through tax haven sales subsidiaries in locations such as Bermuda and Hong Kong. Gary Hufbauer of the Institute for International Economics estimates that such practices could save European companies $10 billion a year in corporate income tax. By comparison, U.S. companies saved about $3.5 billion last year with the FSC.
Notwithstanding our strong disagreement, the U.S. has worked hard to respond to the decision of the WTO Appellate Body by developing bipartisan legislation that completely repeals the FSC and creates a new regime that neither entails a subsidy nor is export contingent.
In its ruling, the WTO panel raised the following objections:
- First, the panel found that but for the existence of the FSC legislation, revenue that would otherwise be fully taxable under the Internal Revenue Code enjoyed a lower rate of taxation. Thus, it found the FSC to be a subsidy because partial tax exemptions accorded by the FSC provisions represented, in its view, a foregoing of government revenue that is otherwise due.
- Second, the panel found that the FSC provisions constituted a prohibited export subsidy because only exports receive preferential tax treatment.
Under the proposed replacement legislation, the general rule is that extraterritorial income-for example, income earned from foreign sales of goods-is not subject to tax. Pursuant to this general rule, the U.S. does not forego any revenue that is otherwise due, but instead refrains from subjecting such income to tax in the first place. Accordingly, the proposed replacement regime is not a subsidy under the test outlined in the Appellate Body decision, which states that a WTO Member has the right to decide which categories of income it will and will not tax.
The proposed replacement legislation also is not contingent upon exporting. Extraterritorial income, which is not subject to U.S. tax under the proposed replacement regime, is defined without regard to whether a good is manufactured within or without the United States. Accordingly, the proposed replacement regime is not export-contingent. The Commission's contention that a subsidy is export contingent if exporters are eligible to use it is, in our view, erroneous as a matter of law.
The replacement legislation is similar to the Dutch system and other European exemption systems because, like the U.S., these systems define a category of income that will not be taxed. Essentially, we have tried to engraft onto the U.S. tax system certain features of European tax regimes, and we find it curious that the Commission would not view that as acceptable.
While there are differences between the category of income defined in the replacement legislation and the categories defined in the Dutch system or other European exemption systems, such differences are not relevant for purposes of the WTO analysis. The Appellate Body acknowledged that members are at liberty to tax or not to tax revenue as they wish.
With regard to the Commission's specific criticism that the U.S. proposal taxes domestic sales more heavily than export sales, we do not think this is relevant to the WTO compatibility of the proposal. In any case, the same assertion can be made of exemption systems in a number of EU member countries-such as France and the Netherlands-which tax distribution income from domestic manufactured goods if sold through a domestic distributor, but not if exported through a foreign distributor.
Significantly, the proposed legislation is the first time that the U.S. has changed a statute to comply with a WTO ruling. It is the product of a truly unique bipartisan and bicameral effort, and we remain confident that Congress will send this bill to the President before it adjourns. We took an important step in that direction last week when the Senate Finance Committee reported the bill out of committee by a unanimous vote. Prior to that, the bill passed the U.S. House of Representatives by a margin of more than three to one.
The only difference between the House and Senate versions has to do with treatment of controlled foreign corporations through the dividends received deduction. We are working with the staffs of the relevant committees in both houses, and with the business community, to find a fair way of dealing with this issue. The House and Senate leadership understands the importance of dealing with this legislation expeditiously. In order to move forward toward the resolution of this dispute, it is critical that Congress pass this new legislation promptly. Passage of this legislation is the only way to meet our obligations in the WTO and avoid an unprecedented confrontation with the European Union.
We regret that the European Commission has neither accepted our proposal nor been prepared to either negotiate or offer constructive suggestions. Indeed, Commission officials have already indicated that they will seek a review in the WTO of our new proposal. The stakes involved in this dispute are very high. We have heard estimates that the Commission is preparing a retaliation list of $4 billion or more. For this reason, it is critical that we continue working together to resolve our differences in a creative and consultative manner.
While it is clear that the U.S. and the Commission have very different readings of the panel and Appellate Body decisions in this dispute, we continue to believe that negotiation rather than confrontation is the better way forward. We need to discuss how to use the procedures of the WTO to resolve our differences over the compatibility of our new proposal with WTO rules. Toward this end, USTR and Commission officials recently held procedural discussions about the sequence by which the Commission might seek a review of our proposal after passage of the legislation by Congress. These are purely procedural and are premised on the assumption that Congress will pass FSC replacement legislation. Otherwise, all bets are off. These discussions are continuing today and tomorrow in Brussels. Yet, let me emphasize again, any potential procedural agreement reached will be moot if Congress fails to adopt the new legislation.
Following the extraordinary effort on the part of the United States to pass legislation that repeals the FSC and complies with the WTO decision, any early retaliation by the EU would be most unfortunate. It would also contrast with the manner in which the United States and Australia worked out a dispute over Australia's subsidy for automotive leather, which a WTO panel found violated WTO rules. In that case, we withheld seeking retaliation, based upon the Government of Australia's good faith efforts, and negotiated until we reached an acceptable agreement. We believe such a process of negotiation is more fruitful, less confrontational and more helpful to international business.
As we move into the future, disputes such as FSC make it clear that we need to be more creative in how we solve the complex and difficult issues that we will encounter with our partners across the Atlantic.
First, we need to be careful not to bring disputes to the WTO that might be better resolved by other means. For example, tax matters such as FSC may be suitably handled in the Organization for Economic Cooperation and Development, which already has launched a useful effort to deal with harmful tax competition issues.
Second, we should use the US-EU Summit process more effectively to resolve trade disputes that cross into other policy areas. We have already used such mechanisms to mitigate EU concerns over unilateral US-EU sanctions and to try to diffuse tension regarding trade in genetically modified organisms. Moreover, we recently reached the Safe Harbor agreement at the July US-EU summit over privacy standards that safeguard consumer data.
Third, we need to involve our partners in the private sector to a greater degree in efforts to resolve trade issues. We can build consensus between American and European business leaders through the Transatlantic Business Dialogue, which brings together both governments and their private sectors in order to reduce obstacles to trade. We should also make increased use of other groups such as the Transatlantic Environment, Consumer and Labor Dialogues. The European-American Business Council can also play an important role in avoiding a potentially serious confrontation.
More broadly, it is important that we not lose sight of the overall economic and political relationship that is so important to both sides, but rather find innovative solutions to our trade disputes. We must nurture and strengthen our overwhelmingly healthy and co-operative relationship that has provided such enormous benefits to our economies and to American and European businesses.
Thank you.