[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]


                                                   S. Hrg. 102-000 deg.

THE WTO'S CHALLENGE TO FSC/ETI RULES AND THE EFFECT ON AMERICA'S SMALL 
                            BUSINESS OWNERS

=======================================================================

                                HEARING

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                      WASHINGTON, DC, MAY 14, 2003

                               __________

                           Serial No. 108-14

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house

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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
PATRICK J. TOOMEY, Pennsylvania      FRANK BALLANCE, North Carolina
JIM DeMINT, South Carolina           DONNA CHRISTENSEN, Virgin Islands
SAM GRAVES, Missouri                 DANNY DAVIS, Illinois
EDWARD SCHROCK, Virginia             CHARLES GONZALEZ, Texas
TODD AKIN, Missouri                  GRACE NAPOLITANO, California
SHELLEY MOORE CAPITO, West Virginia  ANIBAL ACEVEDO-VILA, Puerto Rico
BILL SHUSTER, Pennsylvania           ED CASE, Hawaii
MARILYN MUSGRAVE, Colorado           MADELEINE BORDALLO, Guam
TRENT FRANKS, Arizona                DENISE MAJETTE, Georgia
JIM GERLACH, Pennsylvania            JIM MARSHALL, Georgia
JEB BRADLEY, New Hampshire           MICHAEL MICHAUD, Maine
BOB BEAUPREZ, Colorado               LINDA SANCHEZ, California
CHRIS CHOCOLA, Indiana               ENI FALEOMAVAEGA, American Samoa
STEVE KING, Iowa                     BRAD MILLER, North Carolina
THADDEUS McCOTTER, Michigan

         J. Matthew Szymanski, Chief of Staff and Chief Counsel

                     Phil Eskeland, Policy Director

                  Michael Day, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Crane, Hon. Philip M., U.S. House of Representatives.............     3
Rangel, Hon. Charles B., U.S. House of Representatives...........     5
Hufbauer, Gary Clyde, Institute for International Economics......    13
Lee, Thea, AFL-CIO...............................................    15
Parsons, Doug, Excel Foundry and Machine.........................    17
Fortun, Wayne, Hutchinson Technology, Inc........................    19

                                Appendix

Opening statements:
    Manzullo, Hon. Donald A......................................    25
    Velazquez, Hon. Nydia M......................................    28
    Christian-Christensen, Hon. Donna M..........................    30
Prepared statements:
    Hufbauer, Gary Clyde.........................................    32
    Lee, Thea....................................................    36
    Parsons, Doug................................................    39
    Fortun, Wayne................................................    44
    Coalition for Fair International Taxation....................    47

                                 (iii)

 
 THE WTO'S CHALLENGE TO THE FSC/ETI RULES AND THE EFFECT ON AMERICA'S 
                         SMALL BUSINESS OWNERS

                              ----------                              


                        WEDNESDAY, MAY 14, 2003

                  House of Representatives,
                        Committee on Small Business
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 2:04 p.m. in Room 
2370, Rayburn House Office Building, Hon. Donald A. Manzullo, 
[chairman of the Committee] presiding.
    Present: Representatives Manzullo, Chabot, Graves, Capito, 
Musgrave, Gerlach, King, Velazquez, Udall, Ballance, Christian-
Christensen, Napolitano, and Majette.
    Chairman Manzullo. We will call to order the House Small 
Business Committee.
    Today, the Committee will examine one of the most important 
issues that Congress will have occasion to address this year. 
We will examine the challenge of the World Trade Organization 
to the Foreign Sales Corporation and Extraterritorial Income 
Exclusion rules of the Internal Revenue Code and the effect 
this challenge will have on America's small business owners.
    Like many other countries, the United States has long 
provided export related benefits under its tax laws. For most 
of the last two decades in the United States, these benefits 
were provided under the FSC and ETI tax rules of the Internal 
Revenue Code. In recent years, the European Union succeeded in 
having the FSC and ETI tax rules declared prohibited export 
subsidies by the WTO.
    During August of 2002, a WTO arbitration panel determined 
that the EU was entitled to over $4 billion of annual 
countermeasures against the U.S. for failure to repeal its ETI 
rules. The EU has not yet imposed sanctions against U.S. 
exports, but recently announced it will do so if the ETI regime 
is not repealed before the end of the year.
    A great deal is at stake in the face of the WTO challenge. 
Our domestic manufacturing base is being hollowed out right 
before our very eyes. Something must be done to ensure that a 
viable manufacturing base is preserved in the United States. 
Otherwise, the economic miracle that has occurred in the United 
States will be relegated to the dustbin of history.
    On our first panel we have Congressman Phil Crane and 
Congressman Charlie Rangel, who, along with me, recently 
introduced H.R. 1769, the Job Protection Act of 2003. This bill 
is the only bill introduced this Congress to address the 
current WTO challenge. Once fully phased in, the bill replaces 
FSC/ETI with an effective reduction in the corporate tax rate 
of up to 3.5 percentage points for U.S. manufacturers, or 10 
percent exclusion from income.
    On our second panel we will hear from a panel of experts, 
Dr. Gary Hufbauer of the Institute for International Economics, 
and Ms. Thea Lee of the AFL-CIO. We will also hear from two 
manufacturers, Doug Parsons, president and CEO of Excel Foundry 
and Machine in Pekin, Illinois, and Wayne Fortun, president and 
CEO of Hutchinson Technology, Inc. headquartered in Hutchinson, 
Minnesota, who will provide us with input on how this proposed 
tax law change would practically work.
    I look forward to the testimony of the witnesses. On behalf 
of the Committee, I wish to thank all of them for coming, 
especially those who have traveled far.
    I now yield for an opening statement by the gentlelady from 
New York, Mrs. Velazquez.
    [Mr. Manzullo's statement may be found in the appendix.]
    Ms. Velazquez. Thank you, Mr. Chairman.
    Today, international trade makes most of us think about 
multinational corporations like Coca-Cola, Microsoft or Johnson 
& Johnson, but, in reality, of all U.S. manufacturers more than 
90 percent are small and medium companies, and it is these 
firms that make up the overwhelming majority of exporters.
    These small companies engage in international trade because 
of the benefits it brings them. International trade is key to 
the economic well being of our nation. Exports are a powerful 
engine of economic expansion, accounting for 30 percent of 
total U.S. economic growth over the last decade. Exports are 
also of critical importance for job creation and have accounted 
for the majority of new U.S. manufacturing jobs added to the 
economy over the last several years.
    Recently, globalization, ease of travel and advances in 
technology have not only changed the way we do business, but 
also have made the domestic benefits of exporting more 
difficult to come by. The global marketplace is experiencing an 
overcrowding with increased competition, causing fluctuations 
in labor cost and prices.
    In an effort to improve the competitiveness of their 
companies, many countries, including the U.S., create special 
provisions within their tax system. These tax provisions give 
domestic producers certain advantages that make their output 
more attractive to buyers and sellers on the international 
market.
    The U.S. has provided such export related tax benefits 
under its laws for decades. Most recently, these benefits were 
contained under the Foreign Sales Corporation/Extraterritorial 
Income tax rules. These measures provided tax relief to many 
small exporters that could stay in the game as a result, 
allowing them to do business the old-fashioned way, produce in 
the U.S. and sell the products overseas.
    Yet, the European Union declared FSC/ETI a prohibitive 
export subsidy by the World Trade Organization, which is the 
international body responsible for helping trade to flow 
freely, fairly and predictably between nations. The European 
Union has threatened with action if the U.S. fails to repeal 
the ETI, but such a repeal will prevent small businesses from 
doing what they do best--creating jobs for American workers 
while still generating revenue through exports.
    A repeal of the ETI is not good policy or good politics 
since tax rates matter when companies decide where to locate 
their facilities. Increasing rates here but not overseas could 
create incentives to move jobs, plants and production abroad.
    With our economy in a weak state and a net loss of more 
than 2,000,000 manufacturing jobs since President Bush took 
office, this is exactly the kind of policy that we want to stay 
away from making. Instead, we want to ensure that jobs stay 
right here where they belong, here in the United States.
    In order to solve this pressing issue, my good friend from 
New York, Mr. Rangel, along with Mr. Crane, who will testify 
here today, have introduced legislation, H.R. 1769, the Job 
Protection Act of 2003. This bipartisan measure, which is 
supported by large and small companies alike, is a win/win 
situation. It repeals the current law FSC/ETI benefits, but 
still provides an effective rate reduction for U.S. 
manufacturers through a permanent new tax deduction.
    It also provides generous transition relief. Without this, 
many small companies might have to close their doors due to an 
immediate increase in their effective tax rate. It also averts 
the European Union's threat of sanctions to take effect next 
January, and it will likely be met with satisfaction from the 
WTO and the European Union.
    Today, small businesses face the toughest battle they have 
in a long time--ever increasing competition from overseas, a 
weak domestic economy and thin profit margins. What they need 
right now is increased protection that will upset the 
competitive disadvantages they face in the global arena so they 
can produce more jobs, train more workers and provide more 
revenue to this country's economy. Without this support for 
small businesses, our economy doldrums are certainly here to 
stay.
    Thank you, Mr. Chairman.
    [Ms. Velazquez's statement may be found in the appendix.]
    Chairman Manzullo. Thank you.
    We have a very interesting pair for this first panel. If 
this is not an indication that this is a bipartisan bill, then 
I don't know what is. Would somebody take a picture of these 
two? I want to capture this moment. I am enjoying it 
thoroughly. I have been enjoying it thoroughly.
    Congressman Crane, because you were here first we will 
recognize you first and then with Congressman Rangel.

STATEMENT OF HON. PHILIP M. CRANE, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF ILLINOIS

    Mr. Crane. Thank you very much, Mr. Chairman and Members of 
the Committee. Thank you for inviting me to come before the 
Small Business Committee to offer testimony on the World Trade 
Organization's challenge to the Foreign Sales Corporation/
Extraterritorial Income rules of the Internal Revenue Code.
    Before I get into that, Ms. Velazquez raised a point here 
that reminded me of when I had Charlie out in my district about 
five years ago I think it was, and we had a trade hearing. Were 
you at that? You know, in my district I have giants like 
Motorola's corporate headquarters, Sears, Baxter Abbott, so I 
knew that we were biggies in the export market.
    What was revealing that came out of that hearing was better 
than 90 percent of Illinois' exports came from companies 
employing 500 or fewer. You raised that point about the 
importance of this to small businesses, and it really is. A lot 
of folks do not seem to fully appreciate that we have a lot of 
small businesses in the world market.
    Let me begin by saying that it has been a great pleasure to 
work with you, Mr. Chairman, to craft legislation, H.R. 1769, 
the Job Protection Act of 2003, that will both bring us into 
compliance with our WTO agreements and keep manufacturing jobs 
in America.
    It has also been my privilege to work on this legislation 
with my good friend Charlie Rangel. While Charlie and I do not 
often see eye-to-eye on issues that come before the U.S. 
Congress, in this case, as in all other prior challenges to our 
FSC/ETI provisions, Republicans and Democrats can and must work 
together to enhance U.S. competitiveness.
    As Chairman of the Trade Subcommittee, I have a special 
interest in preserving and promoting free trade throughout the 
world. Trade is fundamental to our relations with other 
nations, and free trade has been the greatest civilizing force 
throughout modern history.
    I have fought for many years to ensure that the United 
States, which is the largest exporter in the world, maintains 
its rightful role as world leader when it comes to trade. The 
Singapore Free Trade Agreement, which essentially eliminates 
tariffs on all goods exported to and imported from Singapore 
and which President Bush signed just last week, is an example 
of the direction in which we should be heading.
    H.R. 1769 achieves two goals. It brings the United States 
into compliance with our WTO agreements, and it is structured 
in such a manner as to preserve, protect and strengthen U.S. 
manufacturing jobs. I would like to take this opportunity to 
address each of these points.
    Mr. Chairman, like our many colleagues who have co-
sponsored this legislation, a number of whom sit on this 
Committee, I believe that we must comply with our international 
trade agreements. To do otherwise could precipitate a trade 
war, which would be unacceptable. Therefore, this legislation 
repeals FSC/ETI immediately and brings the United States into 
compliance with our WTO obligations.
    The issue then is how to best replace FSC/ETI once it is 
repealed. In recognition of the fact that the repeal of these 
provisions raises the tax burden of current beneficiaries by at 
least $50 billion over 10 years, this legislation returns that 
money to U.S. manufacturers. This stands in stark contrast to 
another suggested approach to this problem, which spends the 
money associated with the repeal of FSC/ETI on assorted new 
benefits for the overseas operations of U.S. multinationals.
    In order to understand why the approach taken in H.R. 1769 
is so crucial to protecting our job base, it is important to 
understand why the FSC/ETI benefit exists in the first place. 
U.S. corporations that export manufactured goods pay a 35 
percent corporate tax rate on their profits. In addition, a 
U.S. corporation pays a value added tax when it sells its 
products in Europe. However, current trade agreements allow 
European countries to fully rebate value added taxes at their 
borders. Therefore, many European manufacturers are subject to 
only one level of taxation.
    F.S.C./.E.T.I. compensates U.S. manufacturers for this 
double taxation, thus leveling the playing field. That means 
jobs stay here. Were FSC/ETI to be repealed with no suitable 
replacement, U.S. businesses would have very little reason to 
maintain facilities and, therefore, jobs in the United States.
    To that end, PriceWaterhouseCoopers has published a study 
that indicates 1,000,000 direct jobs and almost 2,500,000 
indirect jobs are on the line. After all, what rational 
business entity would pay two levels of tax when it had the 
option of only paying one? The net result would be that jobs 
and wealth would be artificially transferred to Europe.
    Therefore, the Job Protection Act provides a permanent new 
deduction, which is an effective rate reduction for U.S. 
manufacturers that is fully consistent with our trade 
agreements. Companies that manufacture domestically will 
receive the equivalent of up to a 3.5 point reduction in their 
corporate rate. In addition, this legislation provides a new 
benefit to thousands of small and medium sized businesses that 
have never received a FSC/ETI benefit.
    This is an issue well worth exploring, and I am very 
pleased to have had the opportunity to express my views here 
today. I look forward to continuing to work with you, Mr. 
Chairman, and with Members of this Committee to pass this 
legislation.
    Thank you.
    Chairman Manzullo. Thank you, Congressman Crane.
    Congressman Rangel?

   STATEMENT OF HON. CHARLES B. RANGEL, A REPRESENTATIVE IN 
              CONGRESS FROM THE STATE OF NEW YORK

    Mr. Rangel. Thank you, Mr. Chairman. I want to thank the 
Ranking Member, Ms. Velazquez, my New York colleague, for all 
the work that she does and all of you do in giving us an 
opportunity to testify in support of our legislation.
    I want the new Members not to misconstrue this relationship 
as being long lasting. What is long lasting is that Phil Crane 
and I have fulfilled a tradition of the Ways and Means 
Committee as it relates to trade legislation.
    Believe me, the trade legislation is not Democratic or 
Republican, but it is what is in the best interest of the 
United States of America, and that is why we have worked 
together on the African bill, the Caribbean Basin bill, the 
Virgin Islands and a variety of pieces of legislation that just 
cannot allow foreigners to believe that we are not united in 
our effort to protect the best interests of the United States.
    That is why I was shocked and surprised that the Chairman 
of our Committee would circulate a letter saying that the World 
Trade Organization did not approve of this legislation and 
quoted them because they said, according to Mr. Thomas, that 
they opposed the five year transition.
    First of all, it is none of the WTO's business what 
legislation we have. If the House of Representatives and the 
Senate decide that we want to legislate they can rule on it, 
but to have them interfere with our internal legislation powers 
surprised me that he would do this, and that is why on my own I 
saw fit to call Mr. Langley of the World Trade Organization to 
find out whether his spokesperson was evaluating legislation by 
any Member of the House of Representatives. While he said that 
he was staying out of it, I made it clear that when that flag 
goes up do not look for Democrats and Republicans. You look for 
the United States Congress to respond.
    In addition to that, I made it clear to our U.S. Trade 
Representatives that while I had a difference with the Chairman 
of the Committee, I was working very closely with the senior 
Republican of the Committee, and for me that was good enough to 
be doing.
    Now, basically what are we were talking about? We are 
talking about what we thought was an agreement with the 
international community as related to how we treat exports, how 
we treat their imports and how they treat our exports.
    We have lost the international law battle as it relates 
under the FSC program. We are under the gun now because they 
have threatened some $4 billion worth of tariffs against our 
exports if we do not come up with a solution, so it is 
imperative. They are not asking for a Republican solution or a 
Democratic solution. We have to come forward and say this is 
what our best thinking is as to how we are going to do it.
    The legislation that has been suggested by Mr. Thomas would 
say that we repeal the existing law, and the billions of 
dollars that would be so-called saved or erased be given to 
those people that have seen fit to go overseas to provide the 
goods and services, an incentive for people to leave the United 
States of America in order for corporations to receive tax 
benefits.
    We, on the other hand, believe that if we are talking about 
exports then you are talking about U.S. exporters. You are 
talking about U.S. jobs. You are talking about providing the 
incentive for people to want to produce not only the best 
product, but to know that the United States of America is 
providing incentives for them to export it. All of those people 
who are concerned about jobs not overseas, but jobs in the 
United States of America, you show me anyone that is 
manufacturing for the purpose of going overseas with it. This 
is going to provide them incentive.
    Again, as Mr. Crane has said to Congresswoman Velazquez, no 
matter how big a corporation is, it is the subcontracts that 
really count for small businesses. They are really the 
heartbeat of providing the work and the subcontracts for small 
business to survive. If you allow a large manufacturing 
corporation to collapse, it is not just the jobs there. It is 
the support of smaller businesses that are going to lose.
    Now, we have at least 73 co-sponsors here. We are not 
saying we are right. We are saying we want to be heard. We are 
saying that this cannot be business as usual because no matter 
who prevails what is important, Mr. Chairman, is that this 
Congress speaks in one voice, especially as it relates to the 
World Trade Organization.
    As I said, this is not the first time that Phil Crane and I 
have gotten together in saying that this is a policy that 
supports American businesses, that creates the jobs that are 
necessary for our constituents to do better.
    I appreciate the opportunity for us to come before your 
Committee, and I only hope the Chairman of my Committee is as 
gracious as you have been.
    Chairman Manzullo. Thank you for your testimony.
    I really do not have any questions. The two of you have 
pieced this thing together and said it very well.
    Ms. Velazquez, do you have any questions?
    Ms. Velazquez. Yes. I just would like to ask you given the 
fact that Chairman Thomas is opposed to this legislation, what 
else can we do collectively to get Mr. Thomas to bring this 
legislation, to allow it to take its course in terms of 
hearings in the Ways and Means Committee and bring it to the 
Floor for a vote?
    Mr. Crane. You respond.
    Mr. Rangel. Well, I am inclined to believe that Mr. Thomas 
thinks that he deals with a higher authority than his 
colleagues in the Congress. As a matter of fact, it surprises 
me how little Republicans know about what is going on in the 
Ways and Means Committee.
    Having said that, I would like to believe that this is not 
our Congress. This is an institution that has been created over 
200 years ago, and each of us has an obligation to leave as a 
legacy a House of Representatives that works not for one party, 
but for both.
    I want to reinforce what I am saying, Mr. Chairman. It is 
not whether we win or lose that is important. We want to be 
heard. I think that if we reach the point that 218 people are 
saying that they signed a piece of legislation, the forefathers 
and the drafters of the Constitution have provided a way that 
the majority, if not the minority; the majority can be heard.
    Let us work toward getting that majority. I am certain that 
Phil Crane and I will do all we can to visit each other, 
caucuses to make certain that we are saying that labor, 
business people and American workers want this to be voted on.
    Ms. Velazquez. I have another question. If this legislation 
becomes law, are you concerned that the phasing out aspect of 
the FSC/ETI will be challenged by the WTO?
    Mr. Rangel. I cannot believe that you can have any law that 
does not have a reasonable transition period. It just does not 
make sense when business people have planned on existing law 
that we would just say that tomorrow morning all of your 
investment, all of the things you planned on.
    I am not the least bit concerned about the World Trade 
Organization as it relates to the transition. Any reasonable 
person will have to believe that if you dramatically change the 
existing law you have to give business people, whether they are 
U.S. citizens or foreigners, time to adjust to it.
    Ms. Velazquez. Thank you.
    Mr. Crane. Could I add just one thing--------.
    Ms. Velazquez. Sure.
    Mr. Crane [continuing]. To what Charlie said, and that is 
the banana dispute. We gave them a five year transition period. 
They did not request it even, but we recognized how important 
that is, as Charlie said, to businesses.
    If you are going to change the ground rules, provide for 
that transition to the change. I think it is something that is 
not unreasonable, coupled with the fact that I have had input 
from tax lawyers, and they say that they think it is 
acceptable, and they think that there will not be a dispute 
over that transition.
    Chairman Manzullo. Mr. Chabot?
    Mr. Chabot. Thank you. I just have one brief statement, a 
question for the gentlemen here.
    In light of the WTO's recent ruling against the ETI rules 
adopted by the U.S. in 2000 and amid continuing erosion of 
manufacturing jobs, including in my district in the City of 
Cincinnati, it is imperative that we take steps to ensure that 
U.S. companies exporting goods remain competitive in the global 
marketplace. I would like to thank both Mr. Crane and Mr. 
Rangel for their work to address this important issue.
    Additionally, I believe it is important for us to modernize 
our international tax laws to help maintain and improve U.S. 
competitiveness. As senior and very respected Members of the 
Ways and Means Committee, I was wondering if you could comment 
on whether you would feel that support for your legislation 
could in any way preclude us from also being able to accomplish 
international tax relief for U.S. based companies this year?
    Mr. Crane. This year?
    Mr. Chabot. Yes.
    Mr. Crane. Above and beyond what we have provided for in 
the bill?
    Mr. Chabot. Yes. I mean, would passing your bill in any way 
preclude us from taking action relative to modernizing, 
improving, reforming the international tax laws?
    Mr. Crane. Well, I would say no, it does not, but to give 
you an assurance that this year we can accomplish something 
more, especially with the problems we have going on with that 
other chamber on the Hill, I think would be presumptuous. I 
would hope that we could go beyond.
    When I first came here I introduced a bill that eliminated 
any tax on business whatsoever, and it is because businesses do 
not pay taxes. They gather taxes. That is a cost, just like 
plant, equipment and labor are costs, and you have to pass it 
through and get a fair return or you are out of business.
    If we did not impose that burden on businesses in 
international trade, we would have a huge leg up, and that 
would be totally consistent with any WTO guidelines, but that 
is a long way off.
    At any rate, no. I hope that there are further reforms that 
we might contemplate. In fact, the Chairman has some other 
reforms. I know he has talked about a package of some other 
reforms, and so maybe we will get a chance to do that, too.
    Mr. Chabot. Thank you. Mr. Rangel, I did not know if you 
wanted to comment.
    Mr. Rangel. I would be more than satisfied if I felt that 
we could get some legislation through the House and Senate and 
passed into law on this subject this year.
    Mr. Crane. Yes.
    Mr. Rangel. This is a very controversial subject matter. We 
face a $4 billion penalty against our exports.
    Mr. Chabot, it is not that I like talking to Republicans.
    [Laughter.]
    Mr. Rangel. But there are times that it is necessary.
    Mr. Chabot. I know how distasteful that must be.
    Mr. Rangel. I cannot perceive how we as Members of Congress 
do not believe that we cannot allow the French or the Europeans 
to interfere with our prerogatives.
    You know, even if we have to designate someone to work out 
these difference, Democrats are not going to walk away from a 
fight. We have to make that abundantly clear. The speaker and 
the Minority Leader have to get together and say it is in the 
best interest of the United States of America and the Congress 
to get something out before these Europeans try to dictate to 
us what the hell they are going to do.
    You are talking about international tax reform. Mr. Chabot, 
we are not talking to each other. I think if we can get your 
help to show what we can do with something where everyone 
agrees that it has to be done, maybe that could create a 
climate for us to do more.
    Mr. Chabot. Thank you very much.
    Mr. Crane. One of my great-grandfathers was a Grover 
Cleveland Democrat, but that has been a comfort to me on trade 
related issues because historically, and I used to teach this 
as a former history prop to the kids, and that is that 
Democrats were the free traders and the Republicans were the 
protectionists from the beginning of both of our parties, and 
that lasted until after World War II when we reversed positions 
generally, but not entirely.
    Democrats still had divisions on trade issues within their 
own ranks, just as we Republicans do. We still have, you know, 
the Smoots and the Hawleys on our side, and they still have the 
Grover Cleveland Democrats on their side.
    Grover Cleveland got hit with that panic of 1893 when he 
got reelected to his second term. The Republicans were the ones 
that passed the McKinley Tariff Act that caused that panic of 
1893 to occur. He unfairly took the hit for it, but he 
dismantled it and got the economy moving again.
    He made the observation at the time when you put those 
walls, those tariff barriers, around your country that way you 
inflict the greatest injury on the man who earns his daily 
bread with the sweat of his brow. Amen.
    Mr. Rangel. He has a good memory, has he not?
    Mr. Crane. You know, I know it from my great-grandfather, 
Charlie.
    Mr. Rangel. I did not know you were that old.
    Mr. Crane. It is so good to have somebody like Charlie next 
to me. It is like being with my great-grandfather.
    [Laughter.]
    Mr. Chabot. Thank you, Mr. Chairman. That was worth asking 
the question just to hear that. That was good.
    Chairman Manzullo. I was waiting for Mr. Rangel to say I 
knew Grover Cleveland.
    Mr. Crane. Well, I think he may have.
    Chairman Manzullo. Congresswoman Majette, do you have any 
questions?
    Ms. Majette. Good afternoon. I do not have a question. I 
just have a brief comment.
    As a new Member of Congress and a new Member of this 
Committee, I want to thank you both for your leadership and the 
initiative that you have shown on this issue. It really does 
set a great example for me and for the new freshman class, so I 
appreciate that.
    Mr. Crane. Thank you.
    Mr. Rangel. Thank you.
    Chairman Manzullo. Dr. Christian-Christensen?
    Mrs. Christensen. Thank you, Mr. Chairman. I want to thank 
you and the Ranking Member for holding this hearing and also 
thank both Chairman Crane and Ranking Member Rangel for the 
work they have done on this bill.
    You may or may not know, Mr. Chairman, but this bill also 
has a direct impact on my district, and we have for several 
years now been working to try to develop a way to replace or 
revise the FSC laws so that we could continue to benefit from 
new jobs that it brings in my district. I want to thank them on 
behalf of the small and medium manufacturers of the country who 
we represent on this Committee and also on behalf of my 
district.
    I know that you did say this is our legislation and no one 
has the right to interfere, but there have been several 
attempts to try to address this, none of which have really been 
successful. How does this legislation differ from some of the 
other approaches that have already been rejected?
    Mr. Rangel. Why do I not let you handle this, because the 
WTO--I had not known, and I should have known, that even in the 
Clinton Administration the legislation that we were supporting 
never was thought that it was going to be accepted by the WTO, 
and now it is abundantly clear by Republicans and Democrats it 
was a holding action.
    This is the first real attempt that we are making to deal 
with the problem that we face rather than taking the holding 
action approach, and we repeal--not fix. We repeal the 
impediment that they are raising.
    What we do with the tax savings should be a United States 
concern. If we are dealing with United States business and it 
is based on the percentage of the credit that you get will be 
the percentage of your manufacturing that is being exported, to 
me that is an internal matter, and it is not just served trying 
to give a subsidy to the exports.
    Phil?
    Mr. Crane. I agree with that. The fact of the matter is 
above and beyond some of the immediate concerns that are 
obvious to one and all a bigger concern about the impact of 
this WTO ruling, which is something that we helped to create 
and to provide the guidelines for setting up the conditions for 
playing the ball game worldwide.
    The impact of this on our manufacturing jobs here in the 
United States could be awesome, and that has implications that 
go as far as national security. I think this is a critically 
important piece of legislation. It is urgent. It needs to be 
passed, and it is in the interest of all of us.
    It does not go as far as I would like. As I indicated 
before, I would eliminate any tax on business, but at least it 
provides some relief for those companies that will be taking a 
hit and provides that relief in a way that is not inconsistent 
with WTO.
    Chairman Manzullo. Mr. Ballance, do you have any questions?
    Mr. Ballance. Mr. Chairman, first, this has been one of the 
most exciting hearings I have had an opportunity to sit in on 
since I have been here these four months.
    I do want to ask a serious question, knowing the residence 
of these two fine gentlemen. Does this bill apply below the 
Mason-Dixon line?
    [Laughter.]
    Mr. Rangel. And our possessions and territories.
    Mr. Ballance. Being from North Carolina, we, of course, 
like many other areas in the country, are being hit very hard 
with loss of jobs. When I look at the title of your bill, the 
Job Restoration Act of 2003, immediately it warms my heart 
because I get a lot of calls from all over my district, people 
who are really in dire straits in Roanoke Rapids and in 
Henderson, former textile giants.
    A lot of the small businesses, as you have indicated, that 
were associated with those companies now are looking for the 
opportunities, and so to the extent that this bill would help 
small businesses, and I assume based on what you all have said 
that it would, I certainly would want to be supportive.
    Mr. Rangel. Mr. Ballance, you really do not have to be a 
tax expert. Basically what we say is that with the tax credits 
that are available, do you want to give it to businesses 
overseas, or do you want to give it to businesses in the United 
States. That is it, clear and simple.
    Chairman Manzullo. Mr. Udall?
    Mr. Udall. I think Ms. Napolitano was here before I was, 
was she not?
    Ms. Napolitano. No. You were.
    Mr. Udall. Okay. Let me thank both of you gentlemen for 
your hard work, Ranking Member Rangel, Chairman Crane.
    You alluded to in your testimony the urgency of this. Could 
you tell us what you see in terms of the big picture out there 
and the WTO and how quickly you think this needs to be done and 
why?
    Mr. Rangel. This is subjective, and the answer to that 
question is basically in the hands of the House of 
Representatives.
    The WTO has taken the position that they would not go 
through with the threat of the sanctions if they really thought 
we were working together toward a solution of the problem that 
we admit now exists.
    Mr. Udall. Can we not just serve you two up as a great 
example that we are working together?
    Mr. Rangel. Well, if you exclude other people who are not 
working with us, I think that would work.
    Basically subjectively they want to have the feeling that 
we are not deliberately stringing them out as we have 
effectively done in the past, and so if we were just talking 
together saying it has to be fine tuned that would go a long 
way in preventing them from pushing the sanctions.
    Now, some people believe they cannot afford to do the 
sanctions, but that is a hell of a thing to find out, to have 
your exporters find out they really meant what they said this 
time.
    The most important thing that we can do is to, one, unite 
our efforts to resolve the problem and, two, to let the whole 
world know it. If we did that and they wanted a trade war, let 
us get on with it, but we should not do it without coming 
together as a nation and responding to this need.
    Mr. Crane. I spoke to Mr. Lamee last week on this very 
issue, and he told me that at the end of the fiscal year they 
will make the determination as to whether to impose the 
sanctions. The sanctions would begin starting January 1 of next 
year.
    Mr. Udall. Thank you both very much.
    Chairman Manzullo. Mrs. Napolitano?
    Ms. Napolitano. I am sorry. I came in late so I missed your 
testimony, so I am going to read about it. I was just with a 
group of 77 students who were asking me about the economy of 
California and the rest of the nation, so in essence this is 
something that I am very, very concerned with.
    Coming from California and having a state that does a major 
amount of trade with the world, this is very, very critical. We 
established a task force with many factors to find out exactly 
what some of the issues are. Guess what? It is the valuation of 
the dollar. It is other countries putting support services and 
support dollars behind their companies competing against ours 
so that now we are going to have to start scrambling to keep 
these people in business to provide the jobs so that we can 
rebound our economy.
    I am looking forward to reading your testimony and to 
hopefully getting on your bill because I think this is one of 
the steps that we need to take to be able to move the agenda 
forward and tell them that we are serious and that we will be 
even more if we do not get some solutions moving.
    Thank you.
    Mr. Rangel. Thank you.
    Mr. Crane. Thank you.
    Chairman Manzullo. We want to thank you for coming here. 
The unemployment rate in the district that I represent is at 11 
percent in Rockford, Illinois. This is the city that led the 
nation in unemployment in 1981 at 24.9 percent. Our 
manufacturing jobs are being cored out. Those 2.3 million 
manufacturing jobs are gone. They are gone forever because of 
increased productivity and a lack of sales, et cetera.
    This bill is a building block in the effort to rebuild the 
manufacturing base in this country. We will not have an 
economic recovery unless the people in Washington who make the 
policy decisions understand how critical it is to have a strong 
manufacturing base in this country. Unfortunately, very few 
understand that you have to dig things out of the ground, you 
have to grow things, and you have to make things in order to 
have a viable economy.
    We want to thank you for--Ms. Musgrave, you just came in. 
Did you want to ask any questions or have any comments of the 
two Members that are here?
    Ms. Musgrave. No.
    Chairman Manzullo. Again, Congressman Crane, Congressman 
Rangel, thank you for your testimony.
    Mr. Rangel. Thank you.
    Chairman Manzullo. I appreciate it. We will have the new 
panel set up. Our next witness, Gary Hufbauer is a Senior 
Fellow at the Institute for International Economics in 
Washington. Before joining that organization, he was a 
professor at Georgetown University, and served at the Treasury 
Department as Deputy Assistant Secretary to the International 
Tax Staff.
    Doctor Hufbauer will review the tortured history of the WTO 
challenge to FSC/ETI and its predecessors. We look forward to 
your testimony.

  STATEMENT OF GARY CLYDE HUFBAUER, THE REGINALD JONES SENIOR 
      FELLOW AT THE INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Hufbauer. Thank you very much, Chairman Manzullo and 
members of the Committee.
    As you said, Chairman, mine is a bit of a history lesson, 
but it does not go back to Grover Cleveland. I will try to do 
it in less than five minutes.
    This dispute originates in the ancient, and I think 
unjustified distinction between a direct and indirect taxes. 
Direct taxes include corporate income taxes, and indirect taxes 
include sales, excise, and importantly, value-added taxes.
    In 1960, a GATT working party decided that indirect taxes, 
that is, the sales, excise and then looming value-added taxes, 
could be rebated or not collected on exports and imposed on 
imports, but you could not do these same border adjustments for 
direct taxes; namely, corporate income taxes which were at 
stake.
    Now, as I said, way back in 1960, value-added taxes were 
just coming in as an important revenue source. They were 
nothing like they are today.
    In 1962, the United States enacted subpart F, which 
basically says that when U.S. companies sell through a foreign 
sales subsidiary, located in a low-tax country, that income 
will be labeled foreign base company income; that is, the 
selling subsidiary's income will be subject to current tax in 
the United States. It will not get the advantage of deferral.
    Other countries subsequently enacted quasi subpart F 
provisions, but theirs have never had the teeth, and do not 
today have the teeth that the U.S. subpart F has.
    So when we come to the late 1960s, U.S. manufacturers, 
particularly firms that export manufactured goods, were triply 
taxed and disadvantaged by the regime then in place, the GATT 
rules and our own internal revenue code.
    First, their competitors were relieved of taxes when 
exporting to the United States. Second, U.S. firms who sold 
into foreign markets had no relief from the U.S. corporate tax, 
and those that exported through a foreign sales subsidiary, 
thanks to our own subpart F, were taxed immediately on that 
sales subsidiary income.
    Now, in 1971, or just about 30 years ago now, we had a 
growing trade deficit at the time, and these tax disadvantages 
were widely appreciated by the Congress at that time and the 
administration. The United States enacted the so-called DISC, 
the Domestic International Sales Corporation, which took about 
12 percentage points off the then 48 percentage point U.S. tax 
rate, the corporate tax rate.
    The European Commission challenged the DISC and the GATT, 
and the United States, in turn--and what I felt was a good 
strategy at the time and think would be a good strategy today--
challenged the tax rules then applied by three European 
countries. These four cases came to be known as the tax 
legislation cases. There is more history in my policy brief, 
but basically the plaintiffs won in all cases, and the 
defendants lost. The U.S. lost and also the European countries 
lost.
    That was in the middle of the so-called Tokyo Round of 
trade negotiations. It was widely appreciated, and I was a 
negotiator, a Treasury official at the time, that if we all 
retaliated against each other we would blow up the Tokyo Round.
    So we negotiated it out in the Tokyo Round subsidies code 
and we had a series of provisions which essentially said that 
the United States would in time repeal the DISC, but laid the 
groundwork for what came to be know although we did not have 
the name at the time, the Foreign Sales Corporation. The 
compromise enabled the European countries to continue their 
non-use of an effective subpart F; that is, their use of 
foreign selling subsidiaries for their corporate exports, but 
they had to observe arms-length prices.
    And this agreement and the subsidies code, which is there 
in the text in the notes, was then codified or repeated in the 
1981 GATT Council decision, which then disposed of those tax 
legislation cases which had been held over.
    So in 1981, we had tax peace.
    Now, 16 years later the European Union decides to bring 
this FSC case. I mean, after the 1981 and 1983 decisions, the 
United States repealed the DISC and introduced the FSC, and 
everybody thought this was fine, in accordance with the 
agreements.
    So 1997, 16 years later, the European brings forward the 
case. This had nothing to do with--I know everyone here is 
aware--with any complaints in Europe over our tax practices. It 
had everything to do with cases that Europe had lost in the 
WTO, so they wanted to get tit for tat, and also they were 
building up a negotiating chip for the Doe-Hall Round in 
Agriculture.
    Now, I see I have run out of time, Mr. Chairman. Do you 
want me to stop here or continue forward?
    [Mr. Hufbauer's statement may be found in the appendix.]
    Chairman Manzullo. That is tough to answer. I mean, the 
testimony is great, but perhaps we should move on.
    Mr. Hufbauer. Sure.
    Chairman Manzullo. And then come back. I would like to get 
in as much testimony as we can.
    Mr. Hufbauer. Sure.
    Chairman Manzullo. Before the votes begin if possible.
    Mr. Hufbauer. Sure.
    Chairman Manzullo. Thank you.
    Our next witness is--is it Thea?
    Ms. Lee. That is right.
    Chairman Manzullo. Thea Lee is the Assistant Director for 
International Economics of the AFL-CIO. She is involved in the 
Public Policy Department where she oversees research on 
international trade and investment policy.
    We look forward to your testimony.

  STATEMENT OF THEA LEE, ASSISTANT DIRECTOR FOR INTERNATIONAL 
          ECONOMICS--PUBLIC POLICY DEPARTMENT, AFL-CIO

    Ms. Lee. Thank you very much, Mr. Chairman, Ms. Velazquez, 
Member of the Committee.
    I appreciate the opportunity to testify today on behalf of 
the 13 million working men and women of the AFL-CIO and the 
unions of the Industrial Union Council.
    We believe this hearing is timely for several reasons. With 
sanctions up to $4 billion pending against U.S.-made products 
and all appeals to the WTO exhausted, it is essential for 
Congress to respond.
    The deep prolonged prices in U.S. manufacturing makes it 
even more essential for Congress to examine ways to support 
U.S. manufacturing and exports. The AFL-CIO believes that the 
FSC/ETI can be replaced in a way to bring the U.S. into 
compliance with the WTO and boost manufacturing in the United 
States.
    Ninety-five thousand manufacturing workers lost their jobs 
in April alone. We have now been losing manufacturing jobs for 
33 straight months, the longest such stretch since the Great 
Depression. Since April 1998, the United States has lost 2.6 
million manufacturing jobs, nearly 13 percent of the total 
manufacturing workforce.
    Unless these trends are reversed serious damage will be 
done to the livelihoods of America's working families and to 
the nation's economy. Manufacturing historically has been a 
major generator of good, high-skilled, well-paid jobs with many 
linkages to job in non-manufacturing sectors, and it remains a 
mainstay of local and state economies throughout the nation.
    Manufacturing decline not only undermines the quality of 
manufacturing jobs but also contributes to the stagnation in 
all workers' wages. Moreover, the massive scale of 
manufacturing plant closings and job layoffs is contributing 
directly to the serious fiscal crises afflicting virtually 
every state in the nation.
    The forthcoming debate on the FSC/ETI repeal gives Congress 
a key opportunity to help U.S.-based manufacturing by 
reorienting tax policy. Replacing the FSC/ETI with incentives 
to create manufacturing jobs in the United States is vital to 
the health of the industry and our entire economy. We believes 
that H.R. 1769, the Crane-Rangel-Manzullo-Levin bill, will help 
boost U.S.-based manufacturing, which is why the AFL-CIO 
strongly supports it.
    As you may recall, Mr. Chairman, AFL-CIO Secretary-
Treasurer Richard Trumka testified before this Committee just 
last month, and called for legislation to establish a 
manufacturing tax benefit to replace the FSC/ETI.
    We are pleased that there has been a broad bipartisan 
response to this call on the Congress, and we look forward to 
working with you and others to secure the legislation's 
passage.
    H.R. 1769 would provide a tax benefit for production of 
goods in the U.S., adjusted for the percentage of a company's 
worldwide production that takes place in the United States, and 
we think this provision is particularly important to leverage 
the reward for companies that have relatively more U.S.-based 
production, to reward companies that are producing more in the 
United States. We think that is entirely appropriate.
    In the future the legislation would create an effective tax 
penalty for shifting production abroad. The legislation would 
also phase out FSC benefits over five years, allowing time for 
workers and companies who are FSC beneficiaries to adjust to 
adjust to a new system.
    Representative Bill Thomas last year put forward a proposal 
to repeal the FSC and replace it with a collection of corporate 
tax cuts, most of which would mainly benefit companies with 
overseas production facilities. Multinational corporations 
could accumulate untaxed profits overseas more easily because 
base-company rules would be repealed. Multinational 
corporations would also get tax breaks by using rules that 
allow profits made in countries like Germany and France to be 
converted into tax deductions by paying to expenses to wholly 
or partly owned companies in tax havens like the Cayman 
Islands.
    The Thomas proposal, put simply, would ship more 
manufacturing jobs abroad.
    According to a New York Times story last year even some 
supporters of the bill said that the ability of companies to 
avoid taxes on profits from factories abroad so long as they 
were not returned to the United States encouraged American 
companies to invest and create jobs overseas.
    It is bad enough that bureaucrats at the WTO and the 
European Union are forcing changes in our tax system, but it is 
even worse that some in Congress would respond to this 
challenge by making domestic manufacturing less competitive.
    The Thomas approach purports to be about enhancing American 
competitiveness, but in reality it boils down to boosting the 
profitability of multinational corporations, and allowing them 
to produce anywhere they choose so long as they keep an 
American mailbox.
    We strongly encourage Congress to reject the Thomas 
approach.
    We also feel there is an urgent need to reform or existing 
tax system to remove the tax disadvantages for American 
manufacturers and exports as has already been discussed.
    In addition to these tax policy changes, we believe 
Congress should make other significant policy changes that are 
also important. America's manufacturing workers are the most 
productive in the world, but they operate under enormous 
competitive disadvantages resulting from several factors in 
addition to tax policy, such as unfair trade agreements, an 
overvalued dollar, and foreign currency manipulation, 
inadequate investment incentives, health care costs not borne 
by overseas producers, and foreign government subsidies.
    Unless these problems are addressed soon, American 
manufacturing capacity and jobs may end up permanently lagging 
and our economic strength may be permanently weakened.
    The U.S. productivity and wage gains have been largely 
driven by the performance of the manufacturing sector. We urge 
Congress to start with passing a manufacturing tax benefit, but 
to make that only the first step of a more comprehensive 
effort.
    I thank you, and I look forward to your questions.
    [Ms. Lee's statement may be found in the appendix.]
    Chairman Manzullo. Thank you for that excellent testimony.
    Our next witness is Doug Parsons, President and Chief 
Executive Officer of Excel Foundry and Machine, Inc. in Pekin, 
Illinois. He served as the president and CEO of that company 
since 1999. He has been with the company since 1993, beginning 
as the Assistant Vice President for Manufacturing. He is 
currently responsible for day-to-day management and operation 
of the company.
    Mr. Parsons, we look forward to your testimony.

STATEMENT OF DOUG PARSONS, PRESIDENT AND CEO, EXCEL FOUNDRY AND 
                       MACHINE, PEKIN, IL

    Mr. Parsons. Good afternoon, Chairman Manzullo and Members 
of the Small Business Committee. I appreciate the opportunity 
to come and talk to you about how I view the WTO's FSC/ETI 
decision and how it affects small manufacturers.
    I am the President and Chief Executive Officer of Excel 
Foundry and Machine. Excel Foundry and Machine manufactures and 
supplies precision machine bronze and steel parts for heavy 
equipment-related industries such as mining, crushing and 
mineral processing. Founded in 1929, the company had $13 
million in sales in 2002. Excel, which operates as a Subchapter 
S corporation, has roughly 100 employees, and is located in 
Pekin, Illinois.
    The current Extraterritorial Income regime, as well as its 
predecessor, the Domestic International Sales Corporation and 
the Foreign Sales Corporation, have been integral factors 
increasing export activity by U.S. manufacturers.
    According to the IRS, there are roughly 4300 FSCs in 
existence in 1996, 89 percent of them exported manufactured 
products. Congress first created the DISC in 1971 to level the 
playing field for U.S. companies, large and small, selling 
these products overseas.
    These three types of taxes it has created over the past 
three decades were designated to neutralize some of the tax 
advantages enjoyed by our foreign competitors located in 
countries with territorial tax systems which generally exempted 
income earned outside the company from income tax and exports 
and value-added taxes and other consumption taxes.
    Traditionally, much of the attention in this area has been 
focused on FSC/ETI usage by large companies. These benefits are 
also important to small and mid-sized manufacturers that 
export, and exporting goods and services for Excel as well as 
many other small companies is simply a necessity to stay in 
business.
    Smaller companies often turn to the export tax incentive 
break-in to and effectively compete the global marketplace. 
According to a July 2000 survey by the National Association of 
Manufacturers, small and mid-sized manufacturers save on 
average $124,000 annually by using the FSC.
    It is critically important to continue to encourage export 
activity by these small companies. Of all the exporting 
manufacturers in America, 93 percent are small and mid-sized 
manufacturers. These firms which individually employ anywhere 
from 10 to 2,000 employees together employ roughly 9.5 million 
people.
    Small and mid-sized manufacturers that export add jobs 20 
percent faster than firms that remain solely domestic, and are 
nine percent less likely to go out of business.
    For Excel Foundry and Machine, selling products in the 
international market, whether directly or indirectly, is the 
life blood of the company. International sales are vital to the 
growth and health of Excel, allowing us to expand by adding new 
space, hiring more employees, and making capital investments.
    Direct international sales account for one-third of Excel's 
revenue, and these sales are responsible for the tremendous 
growth, about 30 percent over the past four years. They have 
enabled the company to recently add 20,000 square foot 
expansion of our production facilities and hire five new 
engineers.
    In the past, Excel has used the Foreign Sales Corp. and we 
are currently using the ETI. The benefits provided by FSC/ETI 
justify the additional efforts needed to go into overseas 
marketplaces and compete. For example, the tax system in South 
American countries heavily favor the local suppliers, and the 
FSC/ETI helps to kind of level the playing field.
    The loss of the tax incentives that is provided by the FSC/
ETI would have a tremendous impact on the company, affecting 
revenues and employment.
    There are many hidden costs in doing business 
internationally. In markets where margins are already thin, we 
lose sales due to the uneven playing field. If these sales 
slump, Excel would likely have to cut between three and five 
percent of its employees.
    Excel is also a substantial indirect exporter and 
indirectly beneficiary of the ETI as a supplier to large 
exporters such as Caterpillar. If these exporters were to ship 
production overseas, it is likely that the would not maintain 
the relationship in the United States. So from this perspective 
it is important to note that what is good for the large 
exporters is also good for small exporters like Excel.
    Given last week's final WTO authorization for the EU to 
impose more than 4 billion annual sanctions against the U.S. 
exporters, we are placed that Congress is actively pursuing 
constructive ways to resolve this issue and minimizing a 
detrimental impact to the U.S. manufacturers.
    I am going to jump ahead here and just say as a small 
manufacturer, and we have already identified that there are a 
great number of exporters that are small manufacturers, and 
most likely S corporations, one of the things I do want to 
point out is that the current bill does not include such 
Subchapter S corporation, and I would like to consider having S 
corporations added.
    Thank you.
    [Mr. Parsons' statement may be found in the appendix.]
    Chairman Manzullo. Thank you for your testimony. You 
pointed out correctly that the bill as drafted does not apply 
to S corporations. We are obviously in favor of addressing that 
somewhere in the future and we look forward to working with you 
on that topic.
    I had the opportunity to have lunch with our next witness. 
I was at a different table from Mr. Parsons, and I am sorry we 
did not have a chance to chat about your business. Wayne, is it 
Fortun?
    Mr. Fortun. Yes.
    Chairman Manzullo. Mr. Fortun is President and CEO of 
Hutchinson Technology, Inc. headquartered in--I thought it was 
in Hutchinson, Minnesota.
    Mr. Fortun. That is correct.
    Chairman Manzullo. Okay. Litchfield, what is that?
    Mr. Fortun. A town maybe 14 miles north of us.
    Chairman Manzullo. We missed the landing on that one. Sorry 
about it.
    But HTI produces over 60 percent of the suspension 
assemblies for computer disk drives as well as other precision 
equipment. Mr. Fortun will review the history of HTI, describe 
some of its products. During the course of your testimony, Mr. 
Fortun, if you could share how you have withstood the onslaught 
of manufacturing jobs. You are the only one left in the country 
that manufacture that product, and 98 percent of your sales are 
foreign. It is a fascinating story, and we look forward to your 
testimony.

   STATEMENT OF WAYNE FORTUN, PRESIDENT AND CEO, HUTCHINSON 
                TECHNOLOGY, INC., HUTCHINSON, MN

    Mr. Fortun. I will do my best.
    Chairman Manzullo, and the members of the Small Business 
Committee, thank you for the opportunity to present the view of 
Hutchinson Technology, Incorporated on this very important 
issue.
    Chairman Manzullo. Could you put the microphone closer to 
your mouth?
    Mr. Fortun. Sure.
    Chairman Manzullo. Thank you.
    Mr. Fortun. I am Wayne Fortun, President and Chief 
Executive officer of Hutchinson Technology, Incorporated, or as 
we call ourselves, HTI. I am here today because of the 
elimination of the ETI without a suitable replacement would 
have a sever effect on our company.
    Over 90 percent of our product is exported to Asia, and all 
of our competitors are based there. The benefits of the FSC/ETI 
have kept the playing field level and enabled HTI to 
successfully compete on a global market against Asian 
competitors that enjoy extended tax holidays and pay no income 
taxes.
    Without these benefits, it would be extremely difficult to 
remain globally competitive, and eventually we would have no 
choice but to move our operations to Asia in order to compete. 
This would not only impact our 1900 manufacturing and support 
employees, but the majority of our 1500 technical and 
professional staff as well.
    To help you understand why we believe it is so important to 
provide tax relief to U.S. manufacturing companies, I would 
like to tell you a little bit about our company and the nature 
of the industry we compete in.
    The HTI designs and manufactures suspension assemblies that 
go into computer disk drives. Suspension assemblies position 
the recording head above the disk in the disk drive. We 
manufacture over 60 percent of the worldwide supply of 
suspension assemblies for all types of disk drives, from 
desktop PCs and laptops to servers and enterprise computers 
that power the Internet and manage information to run our 
businesses and our government.
    The HTI is an example of an American business, small 
business success story. We were founded by two young 
entrepreneurs in a rural community in Hutchinson, Minnesota in 
1965. In fact, for the first eight years the company was housed 
in a rented chicken coup. It grew from two employees and make-
shift equipment to the leading global suppliers of suspension 
assemblies. Today we employ over 3,400 employees and have 
manufacturing facilities located in Minnesota, South Dakota, 
and Wisconsin.
    When we began manufacturing suspension assemblies in the 
1970s, the disk drive industry was dominated by U.S.-based 
mainframe computer manufacturers. Computers were big and 
expensive, and the gross margins were attractive. That all 
changed in the eighties when the introduction and rapid 
acceptance of the personal computer. Small, agile start-up 
companies emerged, competition was fierce, and the company that 
could deliver the best drive at the lowest price won.
    In pursuit of lower costs disk drive manufacturers started 
operations in Asia. Correspondingly, HTI's exports grew from 
less than five percent of revenue in 1988 to 92 percent last 
year, in 2002. At the same time the number of our U.S. 
competitors dropped from 34 to zero.
    Today, we have only three remaining competitors. As I 
mentioned earlier, all three are in Asia, and two are in 
countries that offer extended tax holidays and therefore pay no 
income tax.
    Despite numerous requests and in some cases pressure from 
many of our cost-conscious customers to relocate in Asia, we 
have kept our manufacturing operations as well as R&D in the 
U.S. because our U.S.-based manufacturing model has been and 
has given us a competitive advantage.
    Our strategy has been to leverage technology and automation 
to win in our markets. HTI's technology leadership is derived 
from our ability to recruit and retain skilled employees from 
the Midwest labor market. We currently employ over 500 
engineers and technicians, who design and develop equipment, 
processes and products to meet the ever-increasing requirements 
for the disk drive industry.
    We consider our manufacturing workforce to best in class. 
They are trained to operate and troubleshoot our sophisticated 
manufacturing equipment. Each week they produce over 10 million 
suspension assemblies that must confirm to strict quality and 
cleanliness requirements.
    Through our people and our technology, we are able to 
produce the best product at the lowest cost in the world. We 
know we can compete with the best products. However, an 
increased tax burden would make it very difficult for us to 
maintain the lowest cost in an industry where every penny 
counts.
    Since 1997, HTI's taxes have been reduced by $15.5 million 
under the ETI, which has allowed us to invest in technology and 
jobs here in the U.S. Over that same time period the federal 
tax revenue from those jobs was $268 million.
    We are excited about the future in the disk drive industry 
and the potential for growth and new applications for disk 
drives and emerging consumer electronics devices. We believe 
that the automated facilities we have and the skilled labor 
force here in the U.S. will help us to meet those future 
requirements.
    All we need and ask for is to retain a level playing field 
in order to maintain a competitive position. We feel that Jobs 
Protection Act of 2003 is a step in the right direction, and 
helping to maintain the level playing field for U.S. 
manufacturers, and we urge your support of this bill.
    However, it still leaves companies like HTI and others that 
compete in Asia at a disadvantage. To truly level the playing 
field the issue of tax holidays needs to be addressed. If it is 
not, we believe there will continue to be an exodus of jobs to 
Asia, and as we have seen in our industry, it is not the lower 
skilled positions. Those positions have already been lost. It 
is the skilled positions that are now at risk.
    Thank you for your time.
    [Mr. Fortun's statement may be found in the appendix.]
    Chairman Manzullo. Well, this is quite a panel, talk about 
diverse background. I do not quite know where to begin my 
questions, but I guess perhaps, Professor, with this question.
    Have you examined the two competing bills that are, or at 
least the two competing philosophies that are underway, that 
is, the Crane-Rangel, Manzullo bill and the proposed Thomas 
bill, and if so, could we have your comments on them?
    Mr. Hufbauer. Yes, I have examined both of them. And on 
careful reflection I think the Job Protection Act is the better 
one because it more directly answers the problem of 
manufacturing and other exporting firms.
    There are good features of the Thomas bill, in particular, 
its correction of that 1962 provision I was talking about in 
subpart F is a good feature, but that only benefits large firms 
which are able to operate a foreign sales subsidiary, whereas 
the bill we are discussing now, the Job Protection Act benefits 
a much wider range of firms.
    The Thomas bill also has some features in terms of 
consolidating this very complicated foreign tax credit system 
in baskets, dealing with interest allocation provisions--those 
are all good features, and I agree with the general direction 
of the reform.
    But here we are talking about an immediate hit to firms 
that are manufacturers mainly and are exporters, and these 
firms have long been disadvantaged by the U.S. tax law, and I 
think they have the first claim to the available funds from the 
repeal of the FSC.
    Chairman Manzullo. What a great answer.
    Mrs. Velazquez, after that answer I may not want to ask 
anymore questions.
    [Laughter.]
    Ms. Velazquez. Professor, what would you say to those 
critics in the administration to make them understand that a 
strong manufacturing base translates into a stronger national 
economy?
    Mr. Hufbauer. Well, you know, when I was in the Treasury, I 
guess I should have left some instructions for my successor. 
Open this envelope and read it.
    But I know where this view that you are speaking of comes 
from, and I have long disagreed with it.
    When you look at the swings in our trade balance, they are 
all concentrated in manufacturing. All is too strong, but 80 
percent is concentrated in manufacturing. We have been running 
a very strong dollar for quite a few years. It is going in the 
other direction now, but it has led to a huge decimation of the 
manufacturing base in this country, and manufacturing trade.
    And I do not think you can just kind of say, well, you 
know, it is going to come back. There is, I think, new evidence 
coming in that once it goes it stays away.
    I guess for people in business that is pretty obvious, but 
for economists that takes some economic demonstration. So the 
econometric demonstration is coming in.
    Finally, I am very impressed by the evidence that 
production, and again we are talking mainly manufacturing, is 
highly sensitive to tax differentials.
    Now, this was not known 20 years ago and even 10 years ago 
the evidence was not so strong. Now it is extremely strong, and 
some of the best work on that issue has been done in the 
Treasury Department, echoing some of the comments from my 
colleagues on this panel who are, you know, directly affected.
    The U.S. is not a favorable place from a tax standpoint for 
manufacturing compared to other countries around the world, not 
only other countries in Europe and in this hemisphere, but 
generally. We have now slipped to be a rather high tax country 
for this important sector. I know that is rambling, but that 
would be my answer to the Treasury today.
    Ms. Velazquez. Thank you.
    Ms. Lee, H.R. 1769 will formally remove the export 
contingency of tax benefits in the FSC/ETI from the statute, 
which is the most contentious aspect.
    Do you believe that the removal of this provision creates a 
bill that complies with WTO regulations?
    Ms. Lee. I believe that linking the tax benefit to exports 
was one of the key problems that the EU and the WTO had 
identified. So I think that it does seem to me that this is 
very much line with WTO regulations; that it is available to 
foreign or U.S. manufacturers. It does not distinguish between 
them, does not discriminate against foreign manufacturers, and 
for that reason I think we have the right to use our tax system 
in this way, and certainly to give the tax credit to U.S. 
manufacturers.
    Ms. Velazquez. Professor, Mr. Thomas, he has not commented 
on the Crane-Rangel bill, but in February, when he was asked 
about manufacturing tax credits, he said, and I quote, ``I 
think in the short run it doesn't work, and in the long run it 
is a disaster.''
    Can you share your opinion to this Committee on this?
    Mr. Hufbauer. Thank you, Congressman.
    I have not read that statement from Chairman Thomas, and it 
surprises me against the evidence that I have cited, and I will 
be happy to supply names of authors who have done this 
econometric work.
    Manufacturing is highly sensitive, especially firms 
involved in exports, they are highly sensitive to tax 
differentials between jurisdiction, between our own states. 
There is a lot of evidence that they move to the lower tax 
states, and certainly internationally.
    And I think the responsiveness is growing, and over time 
because of a more globalized economy, which brings a lot of 
ability to move which did not exist 20 years ago or even 10 
years ago. So the statement seems to me to be at odds with the 
evidence.
    Ms. Velazquez. Thank you. Yes, my time is up.
    Chairman Manzullo. Yes. Mrs. Musgrave? Mr. Ballance?
    Mr. Ballance. Thank you, Mr. Chairman.
    I have enjoyed the testimonies and I will have no 
questions.
    Chairman Manzullo. Mr. Graves, any questions?
    Okay, who has some questions, just raise their hands? Okay, 
Mr. Napolitano.
    Ms. Napolitano. And I listened to some of it, some of it I 
can understand, some I am still learning. But a question to 
anyone of you is, can you explain how the value-added tax is 
used by the European countries?
    And a follow-up to that is, can you explain to this 
Committee how it is that the Foreign Sales Corporation, the 
FSC, and its successor, the Extraterritorial Income, ETI, were 
found to be in violation of the WTO rules while the value-added 
tax used by most European nations was not?
    Mr. Hufbauer. Thank you, Congressman.
    That is a big question, and my answer would take longer 
than anybody has patience for but let me try to boil it down.
    The value-added tax was put in this category of taxes that 
can be so-called adjusted at the border, and that little phrase 
means you do not have to charge the tax on your exports, and 
when imports come in you can put the tax on them.
    That was the decision made in 1960 and finally crystallized 
by the late 1970.
    So it is a label. It is a label with a result. I think it 
is a wrong result, but anyway that label is there.
    Now coming to why did the FSC and ETI fail, and here we 
come to this dramatic testimony I was giving, but I took too 
long and ran out of time. Basically the reason the FSC failed 
is that the WTO appellate body tossed out the council decision 
which had provided the provision where we could have an FSC. It 
is as simple has that.
    We had the biggest, and I get a little excited about this 
because I was involved in it, we had the biggest negotiation in 
GATT's history over this up to that point in time. It was the 
biggest negotiation. Lots of meetings, lots of senior people. 
We hammered out a deal with the Europeans. It was codified in a 
GATT council decision.
    If you have the time, and I know you are very busy and 
probably do not spend your time this way, but if you actually 
read that FSC decision after pages and pages, the appellate 
body says that GATT council decision was not carried over in 
the so-called grandfather clause that enacted the WTO at the 
end of the Uruguay Round.
    The finding, to be very precise, was not a legal instrument 
of the GATT.
    Now this was to me an amazing finding. It was a result-
driven finding. They wanted to get rid of the FSC. They had to 
get rid of this obstacle, this agreement. They said it was not 
a legal instrument and away we go. Then they applied the rules.
    Now on the ETI the story was a little bit different. The 
Treasury Department and the Congress at the time tried to 
design a ETI which in its fine textual way met the tests which 
were put forward in the so-called FSC decision, and that 
decision emphasized the distinction that the FSC made between 
taxes on exports and taxes abroad.
    So what the Congress did was say, well, the same companies 
can have the same relief on taxes on foreign production, and 
that was with the textual reading of the decision. But it was 
not with the spirit of the decision which was that the 
appellate body did not like relief for direct taxes on exports, 
and they came in with the ETI decision, and blew it away. So 
that is the legal history.
    Chairman Manzullo. Mr. King, did you have a quick question 
because we have to go vote? Go ahead.
    Mr. King. Thank you, Mr. Chair. I would just quickly toss 
this out here to Mr. Fortun for starters, and that would be: Do 
you know what percentage of your export product is embedded 
federal taxation? If we absolved you of all of that tax 
lability, how much could you discount your exported product?
    Mr. Fortun. How much could I discount my exported products?
    Mr. King. Yes.
    Mr. Fortun. I am not sure I fully understand the question.
    Mr. King. Okay. If there were no federal tax built into the 
cost of your products that you export, if we lifted all that 
tax off instead of a tax credit, what percentage would be 
embedded federal taxation?
    Mr. Fortun. I am not sure I have the answer, but I have got 
my tax guy in the back here.
    I think that to put it perhaps another way, currently under 
the ETI/FSC life, we enjoyed a 12.5 percent discount, and we 
are still paying about a total tax of around 15 to 17 percent. 
I have competitors that are still paying zero, and so I am 
still finding a way to compete with them with a 17 percent 
discount.
    And with all due respect to the Professor, any businessman 
would tell you that of course you are going to go whatever you 
can to get your lowest cost. Every percent counts these days. 
And so the fact that we go across state borders or across the 
Pacific and chasing down lower percentage cost is a matter of 
survival.
    Mr. King. Okay. Thank you. And in the interest of time and 
a vote coming up, I will not proceed down that path except just 
to say that I am, and many of us are interested in getting to 
that point where you could be far more competitive than you are 
today, and I think that is the essential core of what we are 
doing here, and we want to work with you and help you in that 
regard.
    Mr. Chairman, thank you for these hearings, and I 
appreciate the time, and I yield back.
    Chairman Manzullo. Thanks for the excellent testimony. The 
committee is adjourned.
    [Whereupon, at 3:25 p.m., the Committee was adjourned.]
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