Border tax proposal, WTO rules and how developing countries could respond

In the article below, the well-known international trade expert and author of several books on the WTO agreements BL Das provides a comment on why the US proposal on introducing a border adjustment tax system would violate the rules of the World Trade Organization, and what responses the developing countries could consider should the proposal be put into effect.

By Bhagirath Lal Das 

A proper examination of the impending US action can be done only after the US issues the order. Right now there is a lot of confusion on what is coming. Besides, many terms in the US trade parlance have local connotation; hence some of them can be fully understood only through specific US examples. However we should be prepared with our views based on whatever provisional information is available at present.

As I see, there are two separate issues to be considered:

1. differential treatment of a domestic product used as input and a like imported product used as similar input in domestic production;
2. differential tax treatment of income based on whether the product is domestically consumed or exported.

Let us take the first issue. Some reports indicate that the proposal is to deduct the cost of domestic input (product) from the income while computing the tax, whereas there is no such deduction if a like imported input (product) is used in the production. If this be the case, such a provision will clearly violate the principle of national treatment contained in Article III of the GATT 1994.

Article III.4 reads: “The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than accorded to like products of national origin in respect of all laws, regulations and requirements affecting their….use.”

If the “use” of the domestic product results in tax reduction whereas the “use” of the like imported product does not get similar treatment, clearly the imported product will get “less favourable” treatment. And that will violate the principle of national treatment contained in Article III. Even without going into the fine print of the provisions of subsidy, such a provision can be successfully challenged in the WTO on this ground.

Now the second issue. Some reports indicate that the proposal is to differentiate between the earning from domestic sale and that from export in the matter of taxation in respect of a product. Here it would appear that the exemption of the tax is conditional on export. Thus some revenue is forgone conditional on export. This practice will clearly qualify for being categorised as export subsidy which is prohibited under Article 3 of the Subsidy Agreement.

In fact the US has gone through a similar exercise once earlier. That is the famous DISC case, the case related to the Domestic International Sales Corporation (DISC). Here a portion of the profit of DISC which was engaged in export was tax free. EEC, the predecessor of EC, raised a dispute in the GATT in 1973. The US went on delaying this matter as was possible in the GATT those days, including giving a new shape and name to the organisation (Foreign Sales Corporation, FSC).

Finally, when the WTO came into being, a panel ruled in 1999 that the US practice was in fact an export subsidy and was prohibited. Thus the matter which was dragging on for about 26 years got finally settled. This case may not be exactly the same as the currently anticipated proposal, but it does point to the fallibility of providing government benefit contingent on export.

Possible responses by developing countries

The main problem with the current proposal lies in the motive behind it. Some members of the present US administration stated at some stage that they would consider policies and measures even at the very edge of the WTO or by stretching the WTO to the extent possible. Thus what we should be anticipating are policies and measures with questionable WTO compatibility and perhaps clearly violating the WTO rules.

The main problem in that situation is that the other countries will have to launch a series of disputes in the WTO which will be very burdensome for the developing countries. Besides, the dispute process can take up to about twenty-seven months in getting final relief and that too without any retrospective relief. Then a chain of such disputes in the WTO against the US may have a political cost for the developing countries and that will weigh heavily while they decide to initiate the disputes.

These appear to be the problems which need the thinking and attention of developing countries. Perhaps, instead of going to the dispute process or along with going to the dispute process, some countries may consider taking some action of their own in the area of goods, services, IPRs and even other areas. But that needs determination. Here are some illustrative examples of the possible actions the developing countries could take.

In the area of goods, many of them have comparatively high “bound” tariffs, particularly in the agriculture sector. They could select some items and raise their MFN tariffs anywhere up to the bound tariffs. Such raising of tariffs in the agriculture sector is likely to be effective in the case of the US where agriculture is a sensitive issue. And raising of MFN tariffs unto the level of “bound” tariff will be fully in conformity with the WTO rules.

In the area of services, the developing countries could select such services on which they have not taken obligations under the GATS. Here they could prescribe some high restrictions for entry, for example, prescribing entry fees etc. Even where they have taken obligations under the GATS, they could select some sectors and some conditions and apply restrictions to the full in case they have not done so earlier. They could select services which may be sensitive for the US.

In the area of IPRs, they could apply the provisions of “compulsory license” liberally in order to encourage domestic producers and discourage foreign producers, particularly those from the US. Naturally this should be done in accordance with their domestic laws which they have formulated on the Patent.

Bhagirath Lal Das is the author of several books on the WTO and on international trade.  He is a former Director of International Trade at the UNCTAD, and a former Ambassador of India to the GATT and Chairman of the GATT General Council.