While major — perhaps fatal — problems with the Foreign Sales Corporation system may prove harmful to the Virgin Islands, there is a hidden silver lining in the situation which has not been discussed in public. (We assume that the governor and the delegate know about this, although they have not mentioned it openly.)
As background, the World Trade Organization in Geneva has decided that the FSC arrangement is contrary to international trading rules and must end by Oct. 1 of this year.
The FSC deal grants U.S. corporations major tax breaks — said to be worth $4 billion a year — if they handle some part, often a very nominal part, of their export transactions through an off-shore jurisdiction, such as the USVI, Guam or Barbados. The WTO regards this as an illicit U.S. government subsidy paid to the exporting corporation.
The last time the feds looked at the situation, they found that there were about 2,000 FSCs on the books in the USVI, but most of them had little more than a post office box and perhaps a minor relationship with a local attorney. The FSCs have not generated much employment in the territory, and certainly goods getting the FSC tax break are not shipped out of Virgin Islands ports.
A teeny fraction of the corporate tax breaks rubs off on the V.I. government, which estimates that it receives about $7 million in registration fees annually via a mild tax on the companies. (Why an estimate for funds received, by the way? Why not hard figures for each of the last several fiscal years? Surely they must be available!)
It is the government's prospective loss of this estimated $7 million that island leaders have been discussing. Two points should be made in this regard:
First is the fact that the FSC system, while wounded, is not dead. The nation has time to negotiate a compromise, essentially with its European trading partners. But while the compromise might salvage part of the system, the interests of the islands are going to count for little as other players — the U.S. cattle industry, the U.S. owners of Central American banana plantations, and major industrial exporters — all seek to get as much as they can out of what may be a complex, multifaceted trade deal which may well cover many issues in addition to the fate of the FSCs.
Second, and more encouraging, is the so-far unremarked potential impact of the loss of the FSC tax break on the federal government's budget process. The loss of a tax break means, among other things, that Washington is going to collect some additional U.S. taxes on exports.
For the sake of argument, let's say that the loss of the FSC-created tax break will mean a reduction in previously subsidized exports, so that instead of the $4 billion that the Treasury calculates it has been losing annually with the FSCs, it collects $1 billion in corporate income taxes as the result of the death of the FSC arrangement.
A billion dollars a year in new revenue, some of which can be linked to the Virgin Islands, would be a major stroke of good luck for the islands and could be used by the governor and the delegate as they seek federal aid to help the V.I. government out of its (partially self-imposed) financial mess.
Why is this helpful to the USVI? The current budget-writing rules in Washington demand that if a program is to be given additional funding, which is what the governor wants, the supporters of that additional funding have to identify either something else in the budget which will be reduced, or a source of additional revenue. That's called "scoring" in Washington parlance.
The loss of the FSC tax break can be interpreted as bringing more revenue to the U.S. Treasury, and the friends of the USVI can use that silver lining to support some financial relief for the islands. However, any such relief is unlikely to come until such time as the territorial government has met Washington's demands for fiscal discipline (e.g. more tax collections and/or a smaller payroll). The governor's office has not come up yet with an acceptable plan along these lines.
The brand-new source of federal funds for relief is there — but accessible only if the USVI can deliver its part of the bargain.
Editor's note: David North, a consultant, often writes about governmental finances.
