The Trade and Welfare Consequences of U.S. Export-Enhancing Tax Provisions


WP/94/50-EA
The Trade and Welfare Consequences of U.S. Export-Enhancing
Tax Provisions by Donald Rousslang and Stephen Tokarick

This paper uses an applied general equilibrium model of the U.S.
economy to quantify the effects of two provisions in the U.S. tax code that
provide tax breaks for corporate export profits: the Foreign Sales
Corporation (FSC) program and the rules for allocating the export profits of
U.S. multinational corporations between domestic and foreign source income.
The model provides estimates of the effects of these two provisions on trade
flows, production, real wages, consumption, and aggregate welfare. It shows
that the welfare effects depend importantly on the degree to which the
United States is able to influence its terms of trade. In the absence of
terms-of-trade effects, these tax provisions improve U.S. welfare because
they offset other distortions in the economy, namely the distortionary
effects of import tariffs. With terms-of-trade effects, however, the tax
breaks have an adverse effect on welfare because they worsen the terms of
trade.

The paper also shows that export tax breaks are a more efficient way of
reducing the anti-trade bias imposed by tariffs than a direct reduction in
U.S. tariffs. Specifically, eliminating the tax breaks, while at the same
time reducing the import tariff to keep the volume of U.S. exports and
imports unchanged, reduces domestic economic welfare. This result occurs
because the tax breaks interact differently with other distortions in the
economy than changes in tariffs. Removing the tax breaks on export profits
exacerbates the effects of existing distortions to a greater extent than an
equivalent change in import tariffs, when equivalent is defined as a
tariff change that leaves trade volume unaffected.