The World Trade Organization yesterday slapped down a multibillion-dollar American tax break as a violation of international trade rules, leaving the United States with a tough decision on whether to kill a provision that benefits the nation’s largest corporations.
The WTO concluded that the tax rule is illegal under international trade rules in a widely anticipated decision after nearly four years of litigation.
The European Union, which brought the case against the United States in 1998, will receive within three months authorization from the WTO to hit American exports with up to $4 billion in trade sanctions.
U.S. Trade Representative Robert B. Zoellick, who has warned that such a step would amount to “using a nuclear weapon” on the international trading system, promised the United States would cooperate with Europe “in order to manage and resolve this dispute.”
“Given prior decisions, we knew this would be an uphill struggle, but we believed it was important to make our case,” Mr. Zoellick said in a statement.
Mr. Zoellick stopped short of saying whether the Bush administration would seek a change in the law, stating only that it would be consulting closely with Congress.
“It is now clear that we have to reform the U.S. tax code not out of desire but out of necessity to maintain international competitiveness,” said House Ways and Means Committee Chairman Bill Thomas, California Republican.
Pascal Lamy, the trade commissioner for the 15-nation European Union, demanded from the United States “rapid proposals” for changing the law.
“Now it is up to the United States to comply with the WTO’s findings to settle this matter once and for all,” Mr. Lamy said.
The case deals with a rule that allows companies to funnel their earnings from exports through paper companies called foreign sales corporations (FSC) into tax havens like the Virgin Islands. This maneuver saves major U.S. companies like Microsoft, General Electric and Boeing about $4 billion each year, but amounts to an illegal subsidy for exports, the WTO ruled.
Europe originally won the FSC case against the United States in 1999. The following year, Congress tweaked the law in a way that preserved the benefits to U.S. companies, in the hope that the WTO would sign off on the provision.
Yesterday’s decision marked the last chance for the United States to reverse prior losses through an appeal.
In March, a WTO arbitrator will decide the value of retaliation against the United States based on an assessment of the FSC’s effect on European exports. Europe puts the number at $4 billion, the United States at zero. In early April, Europe will have permission, but not the obligation, to hit American exports with sanctions.
But few observers anticipate all-out conflict between the United States and Europe over the issue. Mr. Zoellick and Mr. Lamy have shown a knack for managing trans-Atlantic trade disputes over the past year without coming to blows, said Robert Litan, a trade scholar at the Brookings Institution.
“It’s not the start of a nuclear war,” Mr. Litan said. “It is one of a zillion problems that make life difficult.”
Mr. Litan noted that Europe now has “plenty of leverage over the United States” in other disputes. The two trading partners are also wrangling over the Bush administration’s plans to impose massive curbs on steel imports.
Business groups, jittery at the prospect of losing a major perk, have urged that the United States and Europe roll the dispute over the FSC into the new round of global trade talks that began in Doha, Qatar, in November.
That would give officials a chance to change the WTO rules that now prohibit the FSC system, they hope.
“Those discrepancies need to be addressed in the context of a new round to truly and permanently solve the problem that led to this case in the first place,” said Michael Barody, executive vice president at the National Association of Manufacturers.