The Uneasy Marriage of Export Incentives and the Income Tax

This paper investigates the economic effect of tax incentives for American exports. These incentives include a partial tax exemption for export profits (available by routing exports through foreign sales corporations) and the allocation of some export profits to foreign-source income for purposes of US taxation. The analysis highlights three important aspects of these policies. First, official figures appear to understate dramatically the tax expenditures associated with some US export incentives. Correctly measured, total export benefits provided through the income tax are equivalent to a 1 percent ad valorem subsidy. Second, the 1984 imposition of more rigorous requirements for obtaining export subsidies through foreign sales corporations is contemporaneous with a significant change in the pattern of US exports. Estimates imply that the 1984 changes reduced US manufacturing exports by 3.1 percent. Third, there were significant market reactions to the 1997 event in which the European Union charged that US income tax provisions are inconsistent with World Trade Organization rules prohibiting export subsidies. Filing of the European complaint coincides with a 0.1 percent fall in the value of the US dollar and steep drops in the share prices of major American exporters.