Tax Breaks for Big Guns

A new bill would make it cheaper and easier than ever for U.S. arms manufacturers to export military equipment.


In 1976, when the United States was still reeling from the end of the Vietnam War, Congress added a provision to the tax code that reduced by 50 percent the tax breaks extended to U.S. defense companies that export arms. It was all about market share: U.S. companies were so dominant in selling weapons to foreign countries, the thinking went, they didn’t need any extra help.

Twenty-three years later, as shown in the MoJo Wire’s recent special report, “Arms Around the World,” the U.S. share of the global arms-market has increased sharply, even with fewer tax breaks. Yet a growing number of lawmakers are campaigning to repeal the 1976 tax-code provision anyway, and make it even cheaper for U.S. arms dealers to export their wares (and for their customers to buy the weapons). Not surprisingly, the Pentagon — the world’s biggest consumer of military equipment — is solidly behind the effort.

In late February, Congressman Sam Johnson, R-Texas, introduced a resolution he called the “Defense Jobs and Trade Promotion Act of 1999,” which would amend the Internal Revenue Code. Johnson, a member of the House Ways and Means Committee, noted that the tax code allows U.S. companies to establish foreign sales corporations (FSCs) to shield a portion of their foreign-sales earnings from corporate income taxes. But defense products — alone among all exports — are governed by different rules: Because of the 1976 provision, arms exporters can keep less earnings tax-free than can other manufacturers. Whether you agree with U.S. arms-sales policies or not, it’s hard not to see the rule as a sin tax. But that’s not how the bill’s backers are arguing their case: instead, they say the rule puts the U.S. arms-manufacturing industry at an economically dangerous disadvantage in the international arms-market.

“The questionable rationale for this discriminatory treatment, that U.S. defense exports faced little competition, clearly no longer exists,” Johnson wrote in a February 23 letter sent to all House members, asking for support for his bill. “Today, military exports are subject to fierce international competition in every area. Moreover, with the sharp decline in the defense budget over the past decade, exports of defense products have become ever more critical to maintaining a viable U.S. defense industrial base.”

Fierce competition abroad and market discrimination at home — Johnson paints a sad picture. But is it true? The evidence indicates otherwise: The United States remains far and away the number-one exporter of arms on the global market. Even under President Clinton — who promised during his first campaign to review U.S. arms policy “as part of a long-term effort to reduce the proliferation of weapons” — the United States’ market-share continued to grow to a 10-year high of 60 percent in 1992 and 1993. And, as the MoJo Wire’s arms-sales project shows, the United States doesn’t just sell defense technology to NATO allies; it has also readily armed both sides in a conflict, and provided weapons to countries with blighted democracy or human-rights records, like Indonesia, Colombia, and Saudi Arabia.

What’s more, adds William Hartung of the World Policy Institute, it’s already easy to export arms — maybe too easy. “I don’t really believe that U.S. exporters are lacking in support [from the government],” he says. And, Hartung adds, since arms exporters sell “different kinds of products” — weapons and other technologies designed to kill — they should be treated differently than other manufacturers.

For Johnson and his supporters, however, the United States’ current dominance of the arms market is not enough. Johnson has targeted Ways and Means Committee members and succeeded in winning more than 30 co-sponsors for his bill. He is also focusing on members of the important defense committees.

In his campaign, Johnson has a key ally: the Department of Defense. In his February 23 “Dear Colleague” letter, Johnson quotes a letter from Deputy Secretary of Defense John Hamre to Treasury Secretary Robert Rubin, in which the Pentagon declares itself squarely behind “extending the full benefits of the FSC exemption to defense exporters.”

In the letter, Hamre says that “putting defense and non-defense companies on the same footing would encourage defense exports that would promote standardization and interoperability of equipment among our allies.” And, he added, the move could “result in a decrease in the cost of defense products to the Department of Defense.”

Supporters of Johnson’s bill paint the current system as an anachronism enacted during a time of backlash against the military in the wake of the Vietnam War. Loren Thompson of the Lexington Institute, an Arlington, VA-based think tank, says there is “no obvious reason why” the exemption should remain in effect. “No valid national purpose is served, and a number of valid national objectives are undermined by it,” he says.

Like Hamre, Thompson believes foreign sales of weapons to allies makes their militaries better able to fight alongside U.S. troops. Restricting U.S. companies, he says, drives up the price — and encourages foreign nations to buy their weapons from non-U.S. suppliers. And, with U.S. arms dealers looking abroad to sell their wares, the Pentagon could benefit from prices driven lower by global competition.

Thompson also believes that no one who has studied the issue could object to Johnson’s suggested repeal of the 1976 tax provision. Those who do object, he says, are “reflexively anti- military” or solely concerned with the amount of revenue the U.S. Department of the Treasury would lose if arms exporters’ profits were not as heavily taxed. (The House Joint Tax Committee estimated the tax loss if the bill passes to be about $440 million over the next five years.)

But Johnson’s bill has, in fact, sparked to action a coalition of arms-export critics. In a March 12 letter to Treasury Secretary Rubin, 14 representatives of groups like the Federation of American Scientists and the World Policy Institute aim squarely at Johnson’s principal argument — that U.S. arms exporters face far more competition than they did in 1976, so they need more help.

Citing Arms Control and Disarmament Agency figures, the letter states that 25 years ago the U.S. had a 25 percent share of the world arms-market. By 1996, however, that share had more than doubled, to 55 percent. “It is hard to find in these figures the fierce competition of which Congressman Johnson speaks; the value of U.S. arms exports in 1996 was nearly four times that of our next competitor,” the letter states.

As for Johnson’s claim that the tax provision represents unfair discrimination against the defense industry, arms-sales critics ardently disagree, citing the many subsidies the industry receives from the government in other areas. “This support begins with about $30 billion to $35 billion worth of research and development costs per year that the U.S. government provides to this industry and no other,” their letter to Rubin states.

But don’t take their word for it, the critics say — check with the Congressional Budget Office (CBO). According to the CBO, the letter points out, “U.S. defense industries have significant advantages over their foreign competitors and thus should not need additional subsidies to attract sales…. Because the U.S. defense procurement budget is nearly twice that of all Western European countries combined, U.S. industries can realize economies of scale not available to their competitors.”

Supporters of Johnson’s bill, which is similar to measures introduced in previous years, say that no matter what your opinion of arms exports, the tax code is not the place to regulate them. But to critics of U.S. arms-export policy who fear further escalation of arms sales abroad, the tax code is as good a place as any.

The bill has been referred to the House Ways and Means Committee, where it is almost certain to be approved. If it is, its sponsors hope it will fly through the appropriate Senate committees and end up on the president’s desk in time to be enacted January 1, 2000.

Daniel G. Dupont edits the independent newsletter Inside the Pentagon.