President's Corner

Trade Dispute Puts U.S. Defense Jobs at Risk

by Lt. Gen. Lawrence P. Farrell, Jr., USAF (Ret)

September 2002 – As the legislative season heads into the home stretch on Capitol Hill, many companies in the defense and aerospace industries will be wondering whether Congress and Bush administration officials can successfully solve an ongoing international trade dispute that could threaten the viability and competitiveness of key U.S. manufacturers.

The dispute—between the United States and the World Trade Organization (WTO)—has to do with the Extraterritorial Income Exclusion/Foreign Sales Corporation (ETI/FSC) provisions of the U.S. tax code. These provisions were designed to help U.S. companies compete more effectively against European exporters that are heavily subsidized by their governments and enjoy tax rebates on their exports.

In a challenge brought against the United States by the European Union, the WTO found the ETI/FSC to be an impermissible export subsidy. Unless the United States repeals the ETI/FSC, the European Union intends to impose trade sanctions that could cost U.S. exporters approximately $4 billion.
The United States, as a founding member of the WTO, wants to ensure it complies with the organization’s rules. But repealing the ETI/FSC without replacing it with a viable alternative would devastate major U.S companies that employ thousands of skilled workers. Many of these skills are vital to maintaining a healthy defense industrial base.

Essentially, a repeal of the ETI/FSC would act as an instant tax on U.S. exporters. Pierre A. Chao, a prominent defense industry analyst at Credit Suisse First Boston, estimated that key exporters like Boeing and United Technologies could lose $3 billion of market capitalization; Caterpillar, Deere and Walt Disney could lose around $1 billion of market capitalization. The impact on General Electric’s and Intel’s market capitalization could be as high as $15 billion to $20 billion.
Without the ETI/FSC, U.S. companies would be left with unpalatable options. They would have to raise prices to offset the impact of the increased tax (making them less competitive internationally), accept lower margins and earnings (thereby impacting their ability to attract capital) or lower their costs to offset the increased tax rate.

As Chao noted during a hearing of the Senate Finance Committee in late July, lowering costs often means massive layoffs and moving work to lower cost areas.
“The fact that the ETI/FSC repeal disproportionately hits key, good-wage, high value-added U.S. exporting industries like aerospace, manufacturing and high technology is particularly disturbing,” he said.

NDIA is particularly concerned about the future of 800,000 workers in the defense and aerospace industry whose jobs would be in jeopardy if the ETI/FSC is repealed.

Thankfully, key members of Congress, the U.S. Trade Representative, the Treasury Department and industry organizations are making a concerted effort to come up with alternative ways of enhancing U.S. competitiveness other than through the FSC-type tax regime.

A legislative solution is necessary to ensure that the United States complies with its international obligations, so as to avoid economically damaging trade retaliation, U.S. Trade Representative Robert Zoellick told lawmakers at the Senate hearing.

Two NDIA member companies—Boeing and Caterpillar—testified to the Senate Finance Committee about the consequences that the ETI repeal would have on their business. Without the ETI, Boeing potentially would have to relocate or eliminate 9,600 jobs, in addition to 23,000 supplier jobs, said James H. Zrust, a Boeing vice president.

F. Lynn McPheeters, the chief financial officer at Caterpillar Inc., said that the repeal of the ETI provisions would immediately impose a more than $5 billion tax increase on the nation’s exporters—making it difficult for U.S. based exporters to remain competitive NDIA urges Congress, the administration, and U.S. industry to work together to develop an alternative to the ETI regime that provides comparable benefits. In crafting an alternative, it is critical to avoid incentives for companies to move abroad. Companies that have chosen to stay in the United States and produce jobs here at home should not be penalized if and when ETI is repealed.

Zrust pointed out that, in 2001, the aerospace industry was the largest positive net contributor to the U.S. trade balance, producing an industry trade surplus of almost $27 billion. Without tax benefits similar to those under ETI available to the U.S. industry—our balance of trade will suffer.

Obviously, the ideal outcome would be to achieve a WTO compliant solution that keeps U.S. exporters competitive. A member of the Finance Committee, Sen. Charles Grassley, D-Iowa, noted that the present dispute over how to tax the foreign earnings of U.S. corporations is not new. We have been wrestling with this question in one form or another at least since the late 1960s.

At a time when critical U.S. defense and aerospace industry skills and manufacturing capabilities are at stake, it is important to find a solution to the tax code that satisfies our international trade obligations but also protects our national interest.

I should point out that the topic of ETI/FSC was included in NDIA’s Top Issues for 2002. Our recommendation, which was published early this year, called for engaging in immediate, high-level negotiations with the European Union, aimed at averting the imposition of undesirable duties on U.S. exports.

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President's Corner

Trade Dispute Puts U.S. Defense Jobs at Risk

by Lt. Gen. Lawrence P. Farrell, Jr., USAF (Ret)

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