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.