CRS Analyzes European Action Regarding FSC/ETI Case

Retaliatory tariffs that have been implemented by the EU stem from a continuing delay by the United States to comply with WTO rulings. The WTO found that U.S. tax legislation (the FSC and ETI provisions) relating to export income constitute an unacceptable export subsidy under the Agreement on Subsidies and Countervailing Measures. When the WTO arbitrator determined on August 30, 2002, that the EU could impose tariffs on $4 billion (an amount roughly equal to the annual value of the U.S. export subsidy) of U.S. exports, EU officials indicated they would not apply the tariffs as long as the United States was making progress towards WTO compliance. However, upon receiving final WTO authorization to retaliate on May 7, 2003, EU officials stated they would begin imposing tariffs by January 1, 2004, if the repeal of these tax provisions was not signed into law by then. In November 2003, EU officials again delayed the imposition of the retaliatory tariffs until March 1, 2004, provided that Congress passed legislation to bring the United States into compliance with its WTO obligations. While bills (H.R. 2896 and S. 1637) that would repeal the ETI over a three-year transition period were reported out of both the House and the Senate tax-writing committees in 2003, there was no floor action on the bills in either chamber prior to March 1, 2004.¹

Subsequently, the Senate passed its ETI repeal bill (S. 1637) by a vote of 92-5 on May 11, 2004. The House passed its bill (H.R. 4520) by a vote of 251-178 on June 17. The Senate voted July 15 to replace the language of the House-passed bill with the wording of its own bill, a procedural step necessary to take the two bills to conference, and also appointed conferees. In October 2004, conference agreement was reached and President Bush signed the bill, which became know as the American Jobs Creation Act, into law (P.L. 108- 357). While this legislation removed most of the tax break, the EU moved to challenge the legality of transitional arrangements for its abolition and the "grandfathering" benefits for U.S. corporations that had already signed contracts.

This current episode of trade brinkmanship is being fought out under the auspices of the WTO's Dispute Settlement Understanding ( DSU). According to the DSU, a WTO member found to have violated WTO obligations is expected to comply by withdrawing or eliminating the offending measure. If the complaining party believes that the other Member has not complied by the end of the compliance period, it may negotiate a compensation agreement or it may ask the Dispute Settlement Body for authorization to suspend concessions (usually the imposition of higher duties on items from the other country). The purpose of "suspension of concessions," which is referred to interchangeably as retaliation or countermeasures, is to restore the balance of concessions that existed before the adoption of the rule or provision that had been nullified, as well as to serve as an incentive for compliance.²

Since the WTO went into effect in 1995, the United States has imposed retaliatory duties on EU exports in two cases: bananas and beef. In both cases, after many years of litigation, the WTO found in favor of U.S. petitions alleging that an EU import ban on beef treated with hormones and a system of import quotas for bananas were discriminatory and violated WTO rules. In 1999, EU offers of compensation for lost exports in lieu of lifting its beef hormone ban or changing its banana regime were rejected by the United States and 100% tariffs were imposed on $307 million ($191 million for the banana case and $116 million for the beef case) of imports from the EU, principally luxury products such as Danish ham, truffles, Roquefort cheese, and Italian handbags. Exports from Britain, Spain, and France were mostly targeted in the banana case and exports from France, Germany, Italy, and Denmark in the beef case, because these countries were deemed most responsible and supportive of the discriminatory policy in the respective cases.³ Although the United States in 2002 lifted the 100% retaliatory duties related to the banana case after changes in EU policy, the tariff on beef remains in effect today -- a matter of considerable continuing dispute between the two sides.

For its part, the EU came to the brink of imposing retaliatory tariffs in reaction to President Bush's March 2002 decision to provide the U.S. steel industry with safeguard tariff protection. Claiming that this action violated the WTO safeguard agreement, the EU won its challenge before the WTO and was prepared to impose retaliatory tariffs against $2 billion in U.S. exports. In drawing up its retaliation list, the EU targeted goods made in states that are considered swing states in the presidential election. As shown in Table 1, U.S. Sectors on Steel Retaliation List, categories of steel, textiles and apparel, citrus (found in the vegetables, edible fruits, and nuts category) and fruit juice accounted for 53% of the total trade targeted. Ohio, Pennsylvania, and West Virginia are prominent steel producing states, the Carolinas prominent textile and apparel producing states, and Florida a prominent citrus producing state (California also is a large citrus producer but exports a relatively small amount to Europe).

FSC Retaliation List

Unlike the steel dispute, Congress, not the President, has to take action to bring U.S. law into conformity with WTO obligations in order to settle the FSC/ETI case. Perhaps with this important difference in mind, the EU drew up a retaliation list that appears much more diffuse in terms of geographic impact on producers and states than in the steel case where retaliation was concentrated in a few states arguably pivotal to next November's presidential election. The list tilted heavily towards a large number of products that seemingly could be made just about anywhere in the United States. The list also excluded politically sensitive products such as citrus fruits, orange and grapefruit juice, cigarettes, apples and rice that were on the steel list. Steel and textile and apparel products were also targeted less heavily. To avoid disruption to EU production, the list was also skewed towards consumer goods rather than component parts or intermediate goods.

As shown in Table 2, U.S. Sectors on FSC/ETI Retaliation List, the precious stones and jewelry sector, was most heavily targeted. Accounting for 36% of the total trade targeted but less than 3% of total U.S. exports to the EU, this sector consists of products such as diamonds, gold, silver base metals and jewelry. Major jewelry producing states included New York, Massachusetts, Rhode Island, and to a lesser extent California, Florida, Texas, New Mexico, and New Jersey.

The next four sectors impacted most heavily -- machinery and mechanical appliances, wood and paper articles, leather and leather articles, and toys and sports equipment -- account for 35% of the total targeted trade. Products listed from these sectors also could be made in many different states and regions of the United States. For example, in the machinery and mechanical appliances sector, products such as piston engines, hydraulic turbines, refrigerators, household scales, cranes, fork-lift trucks, and machine tools are included. The wood and paper products sector includes products such as particle board, building materials, plywood, wood panels, paper and paperboard, wallpaper, toilet paper, note books, and unused postage stamps. The leather sector comprises products such as raw hides and skins, and articles of leather such as handbags, briefcases, and gloves. And the toys and sports equipment sector includes such items as doll carriages, dolls, electric trains, billiard tables, cross country and downhill skis, tennis racquets and balls, ice skates, and fish-hooks.

As shown in Table 3, Major U.S. Sectors Excluded From FSC/ETI Retaliation List, sectors totally left off the retaliation list account for close to 40% of U.S. exports to the EU. In addition, exports from the two largest U.S. export sectors (machinery and electrical machinery) were targeted minimally (less than $1 billion of the $49 billion in exports from these sectors). As these latter two sectors account for 34% of U.S. exports to the EU, it can be seen that close to 75% of U.S. exports to the EU were basically nontargeted.

The non-targeted sectors are characterized by massive amounts of cross-investment and intra-industry trade that integrates markets tightly. Trade data, for example, show that the seven largest categories of U.S. exports to the EU (machinery, electrical machinery, optical equipment, aircraft, vehicles, organic chemicals, and pharmaceuticals) are also among the top nine categories of imports from the EU. These seven sectors accounted for 70% of U.S. exports to the EU and 61% of imports from the EU in 2002.⁴ Many of the products in these key sectors, such as aircraft parts, auto parts, and chemicals, are components in products that EU companies export back to the U.S. or components in products that European subsidiaries of U.S. companies use in their production process. Other items such as optical devices and medical equipment may not necessarily be produced in the EU. Most of the exports from the machinery and mechanical appliances and electrical machinery sectors were left off the list as well, due perhaps to similar concerns about hurting or disrupting EU producer interests.

Possible Outcomes

Barring any action by Congress to eliminate the transitional export tax benefits that remain under the American Jobs Creation Act, the EU is threatening to reimpose the sanctions by May 2006. Given the value of the tax breaks that remains, the EU reportedly plans to reimpose sanctions on $336 million worth of U.S. exports -- a level that may be disputed by the United States depending on its calculation of the estimated value of the remaining tax benefits. While the EU could impose tariffs as high as 100% of this amount of trade, most observers believe that it will choose a much smaller retaliatory tariff. (Brussels in 2004 was permitted to impose 100% tariffs on $4 billion of U.S. exports, but opted to impose an escalating tariff beginning at 5% and culminating at 17%). When the EU suspended sanctions in January 2005, sanctions had reached 14%. But at this writing, it is not known for certain whether the EU will target the same products as before and/or at what level.

The EU's plan to reimpose sanctions has aroused a strong U.S. reaction. The Office of the U.S. Trade Representative issued a statement urging the EU not to reimpose sanctions and argued that "new sanctions will reinforce the perception that the EU is primarily acting in response to the U.S. filing of a WTO complaint against Airbus subsidies." Senate Finance Committee Chairman Charles Grassley stated that the "Europeans seemed to have appreciated and accepted our compliance efforts until we raised the issue of Airbus subsidies in the WTO. The blatant linkage of WTO disputes is a dangerous precedent."

       Table 1. U.S. Sectors on EU Steel Retaliation List

² For elaboration see, CRS Report RL32014, WTO Dispute Settlement: Status of U.S. Compliance in Pending Cases, by Jeanne J. Grimmett.

³ Higher tariffs are intended to increase the cost of targeted items to consumers and, thus, lead to declining purchases. Companies and workers hurt by declining sales, in turn, could be expected to lobby their representatives for a change in policy.

⁴ Data from the World Trade Atlas, a subscription trade statistics database, was compiled by J. Michael Donnelly, Information Research Specialist, CRS.