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Wall Street Journal

January 17, 2002

Review & Outlook:
Pandora's Trade War

The first thing to know about the latest trade fight between the U.S. and Europe is that it's not about trade. It's about taxes. And therein lies a tale of how the World Trade Organization has run amok.

This spat has become testy this week with the WTO's $4 billion ruling in favor of Europe's objection to a U.S. law that gives a tax break to exporters who operate through offshore subsidiaries. If this dispute were about bananas or steel, we'd say fair enough, the WTO has spoken, and the U.S. should live with it.

But Europe is up to something other than free trade here. It's really trying to protect its own high-tax policies, especially the VAT or value-added taxes that feed Europe's welfare states. With rates as high as 25% on every level of production (see chart), a VAT hurts the global competitiveness of European companies.

But rather than do the straightforward thing and reduce their tax burdens, Europe's politicians do the tricky thing: They let companies get a rebate on their VAT levies for exports. American tourists benefit from this when they file for a VAT rebate on their European purchases as they depart de Gaulle or Shannon airports. This is a tax subsidy for European exports, which is of course what the U.S. offshore export loophole also is. That's no doubt precisely why some U.S. companies lobbied for it.

Our main question is, Why does this have anything to do with the WTO? That body is supposed to deal with trade disputes, namely tariffs, quotas, "voluntary restraints" and the like. Such direct export subsidies as farm payments, especially when they are industry-specific, deserve to be a WTO concern. And perhaps a highly specific tax subsidy would raise some trade worry.

Into the VAT
Value-added tax rates

COUNTRY      VAT RATE     COUNTRY     VAT RATE    

Denmark                  25%          Greece             18% 

Iceland                      24.5%         Netherlands   17.5%

Norway                     23%           U.K.                  17.5%

Finland                      22%           Portugal          17% 

Austria                      21%           Spain               16% 

Belgium                    21%          Germany          15%

Ireland                      21%          Luxembourg     15%

Austria                      20%           Turkey              15%

Italy                          20%          Cyprus             8%

Sweden                     20%           Switzerland       7.5%

France                       19.6%         U.S.                  0%  

But by vetting general tax policy the WTO is opening a Pandora's Box of political trouble. If the WTO is going to go after offshore export loopholes, why not go after Europe's VAT export rebate too? For that matter, Belgium lacks a capital gains tax, which is something we applaud but which also helps Belgian companies compete abroad; is that a trade violation too?

Once tax policy is on the table, there's no end to what the WTO might meddle in. Which may be exactly what some Europeans want. Saddled with their own anti-competitive, high-tax regimes, they'd love to use the global trade bureaucracy to force Britain, the U.S. and other lower-tax countries to become just as uncompetitive. This is an offer the U.S. can refuse.

Europeans may also want to ask themselves, now that they've got this WTO victory, what are they going to do with it? The EU could slap $4 billion in annual compensatory tariffs on U.S. imports as early as April if it chooses to. But that would punish European consumers, not to mention invite a tit-for-tat exchange with the U.S. that would do broader economic damage to everyone.

The U.S. might decide to repeal the export loophole, though it's unlikely the U.S. Congress is going to vote in effect to raise corporate taxes amid a recession. More likely, the Bush Administration will be under political pressure to retaliate, perhaps by filing a WTO complaint against Europe's subsidies of Airbus.

In short, all of the incentives are for the U.S. and Europe to work this out before it turns ugly. And the lesson for the WTO is to stick to its trade knitting. The more the WTO tries to be a world supergovernment that trumps national tax policies the less it will be able to do its real job of serving as an independent trade referee.

 

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