South-Western College Publishing - Economics  
New Law Eliminates Illegal Subsidies
Subject Foreign Sales Corporation
Topic International Finance
Key Words

Subsidies, Tax Breaks, and Global Competition

News Story

Pascal Lamy, the European trade commissioner, announced an end to a long dispute between the E.U. and the United States. The World Trade Organization raised the issue of a U.S. tax program, known as the Foreign Sales Corporation, which provided illegal subsidies to large American companies in the form of tax breaks.

The European Union claimed the tax breaks reduced global competition among E.U. members and U.S. producers. President Bush signed legislation that ended the tax-breaks that had been worth billions of dollars to American corporations over the last decade. The E.U. responded by lifting sanctions it had imposed on American products.

The legislation results in a two-year period during which the American companies will wean themselves off the old tax- breaks. In 2005, $4 billion (or 80 percent of the original tax breaks) will still be available to companies. In 2006, this amount will be reduced to $3 billion (or 60 percent of the original amount). In the third year, all subsidies will be eliminated.

Mr. Lamy accepted the transition period, but balked at a separate provision that would allow American companies that make products with long delivery times to continue to get the tax break if they have orders dated before September 17, 2003. "Our intuition is that this isn't in conformity" with the W.T.O. ruling, Mr. Lamy said.

Richard Mills, a spokesperson for the U.S., said that the new legislation had eliminated the provisions of the tax code that the W.T.O. ruled illegal. "We will continue to explain to the E.U. and others how the new law brings the U.S. into compliance," he said.

Trade experts said Mr. Lamy's mixed message welcoming the bill and at the same time saying it did not go far enough was simply rhetoric. "He recognizes that for the Americans to abolish the F.S.C is a big deal, because it means doing away with something that has been part and parcel of business life for decades," said Philip Bentley, a trade expert and partner in the Brussels office of the law firm Stanbrook & Hooper.

(Updated December, 2004)

Questions
1.

Define a tax subsidy.

2. Do you think that the two-year period to eliminate the tax-breaks is a good idea? Why or why not?
3. The E.U. responded to the previous American tax-breaks with sanctions on American products. What does this mean?
Source Paul Miller, International Herald Tribune, "European Union Removes Sanctions on American Products," The New York Times Online, October 26, 2004.

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