The American Jobs Creation Act of 2004

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No. 8 in the Series "Tax Policy Issues and Options"

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In its last bit of pre-election tax policymaking, Congress passed the American Jobs Creation Act of 2004. The heart of the bill is a repeal of an illegal trade subsidy—the Extraterritorial Income (ETI) exclusion—plus a potpourri of new tax breaks for businesses (box 1).

The bill is designed to be revenue-neutral, but it follows recent practice of using artificial sunset provisions to obfuscate the true cost. Many of the new tax breaks, such as small business expensing and the deduction of state and local sales taxes, are ostensibly temporary. It is hard to imagine, however, that the political pressures that produced those provisions will dissipate over the next few years. If the new tax breaks are extended, one estimate suggests that the bill could add over $80 billion to the deficit over the next 10 years (Friedman 2004).

Repeal of the ETI exclusion is an important and necessary step. However, the tax reductions proposed in the legislation are not the best way to help businesses, even assuming that tax breaks are warranted.

The Extraterritorial Income Exclusion

The original purpose of the American Jobs Creation Act of 2004 was to repeal the export tax incentive, which the World Trade Organization has repeatedly ruled illegal. As retaliation for the export tax incentive, the European Union has levied tariffs on more than 1,600 U.S. products. Tariffs began at 5 percent in March 2004, and have risen 1 percentage point a month since.¹ Repealing the export tax incentive is good tax policy and good trade policy. There is no reason for the tax system to favor export income. Export income is not especially likely to stimulate the economy and does not generate other special benefits. In addition, resolving the ETI issue could benefit future multilateral trade liberalization and resolve a longstanding trading dispute with the European Union, our largest trading partner.² Once the repeal is in place, the European Union will remove its tariffs on U.S. products. The U.S. terms of trade will also improve, benefiting the U.S. economy by about $5–6 billion a year.³

Further, the U.S. current account deficit is an outcome of the U.S. economy's savings/investment imbalance, not trade measures or tax policy (box 2). Thus, even if exports were considered desirable, the export tax incentive would not effectively improve the trade balance.

Notes from this section

1. See European Council regulation no. 2193, 8 December 2003. As of November 2004, the tariffs stood at 13 percent. The European Union announced that it will suspend the tariffs effective January 2005, when the American Jobs Creation Act takes effect.

2. Considering the European Union as a whole, trade with Europe (exports plus imports) totaled $395 billion in 2003, slightly more than trade with Canada, which totaled $394 billion. (From the U.S. International Trade Commission web site, http://dataweb.usitc.gov/.)

3. An export subsidy (or a tax break for export income) worsens a country's terms of trade by lowering the price of its exports on world markets. This occurs for the same reason that a subsidy to a domestic firm making a particular good would be expected to lower the market price of that good. With the subsidy, the firm is more willing to supply the good, so the market equilibrium price of the good falls. This terms of trade effect affects export prices but need not influence the trade balance, which is determined by the savings/investment balance of the country, as explained in the box. For an estimate of the magnitude of this effect, see the Congressional Budget Office, letter to Nickles, dated 24 February 2004, "An Economic Analysis of Alternatives to Tax Reductions in S. 1637."

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