A Pork Dinner for Multinationals

The U.S. international tax code is a mess -- and the big rewrite Congress is wrapping up will only make the corporate giveaways worse

By Howard Gleckman

Grab your wallet. Washington is trying to fix another tax problem. For years, U.S. exporters, such as Boeing (BA ), shared up to $5 billion in annual tax breaks. But in 1999, the World Trade Organization (WTO) ruled that the largesse violated international law, and the European Union won the right to hit U.S. products with billions of dollars in tariffs and other penalties.

That should have spurred Washington to rethink its international tax code, which has become a complex and inefficient mess. But instead of real reform, the controversy has generated a free-for-all among business lobbyists and threatens to produce a classic corporate tax giveaway.

On Oct. 1, the Senate Finance Committee passed a bill that looks more like an early Christmas tree than a serious fix to a big problem. Within the next week or two, the House Ways & Means panel is expected to follow suit. And, with the EU threatening retaliation if Congress does not act by yearend, a mad scramble to meld the two bills over the next few months may ensue.


  The result, unfortunately, is likely to be a particularly ugly mess. For example, any compromise will probably tax U.S. manufacturers, which employ just 11% of the nation's workforce, at a lower rate than the fast-growing service industry. From a tax-policy perspective, this makes no sense. It will give companies all sorts of opportunities to play games with the tax code.

It's the worst sort of winners-and-losers industrial policy. And it's not likely to create many jobs. It's not taxes that cause most manufacturers to flee the U.S., it's their ability to hire workers overseas for low wages and no benefits.

So why are pols cutting manufacturing a special deal? Simple: Industrial states such as Illinois, Ohio, and Pennsylvania will be crucial to the 2004 campaign, and lawmakers want to make it look as if they care about manufacturing workers. "It's all about the election," concedes one GOP tax aide.


  The manufacturing tax break is just the beginning. The Finance Committee bill also includes a new giveaway for U.S. multinationals. Today, those corporations are supposed to pay a 35% tax when income they earn overseas comes back to the U.S. But those businesses have figured out ways to keep the money in other countries and avoid the tax.

The Finance panel would offer them a deal: Bring those foreign profits back to the U.S. within the next six months, and you'll have to pay only a 5.25% tax. That's a sweet reward for clever tax planning. Says Brookings Institution economist Bill Gale: "It's a combination of the most cynical lobbying and a desperate effort to stimulate the economy."

It gets worse. There's a $600 million-a-year tax break for the movie business and a $180 million giveaway to the timber industry. There's a $150 million tax break for some purchasers of broadband equipment (that's supposed to be because broadband is the future of the nation's commerce -- a line not heard since they said that about the dot-coms). And there's a $1 million goodie for makers of bows and arrows. Maybe they're the future of the U.S. economy too.

And don't forget the deal that allows foreign visitors to avoid paying withholding tax on their winnings at the track. That will cost about $3 million a year. At least the Finance panel bill won't add to the deficit. The House version is likely to deepen the red ink by at least a further $100 billion over the next 10 years.


  Without a doubt, the international tax law needs to be fixed. For all the mind-numbing paperwork it generates, the effective tax rate on U.S. multinationals is less than 3% and, according to some estimates, may actually be less than zero (many companies may get tax refunds on profits they make overseas).

However, the end result of congressional action may be a bill that substitutes one set of paperwork headaches for another, says John Peterson, who heads the global tax practice at law firm Baker & McKenzie. Rather than simplifying or rationalizing the taxation of multinationals, it will just layer billions of dollars in new special-interest tax cuts on top of an already ungainly system.

Even economists who normally love business tax breaks are frustrated that Congress isn't fixing what so badly needs to be repaired. Says Heritage Foundation economist Daniel Mitchell: "They're about to blow the opportunity."

Business lobbyists, who worked hard for President Bush's three tax cuts, say it's time for a reward. After all, less than 10% of the more than $2 trillion in Bush tax breaks were aimed at their companies. Everyone feels their pain. But the measures now working their way through Congress are the wrong fix to a real problem.

Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views in Washington Watch, only on BusinessWeek Online

Edited by Beth Belton

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