RGE - US to China: See you in court (maybe)
リンク: RGE - US to China: See you in court (maybe).
Brad Setser | Feb 07, 2007When I saw that the US was initiating a WTO case challenging China's various tax favors and export rebate, I knew who to turn to for analysis.
Emmanuel -- a regular participant in the comments section - has long encouraged me to take a closer look at China's export rebates in particular.
Rather than do that, I decided to give the floor over to him for a day. Emmanuel's guest post follows.
Emmanuel:
The dispute over China’s large and growing trade imbalance with the United States centers on the perceived undervaluation of the yuan. Yet, other components of Chinese trade policy aside from its foreign exchange regime have largely eluded attention--until now. US Trade Representative Susan Schwab has just requested dispute settlement consultations with China in the World Trade Organization over Chinese measures that appear to contravene WTO rules. These consultations are just the first step in what may end up in judicial proceedings, though only about forty percent of such disputes reach the point of being resolved through rulings. If the US and China are unable to resolve this dispute after a period of bilateral consultations lasting sixty days, then the US can ask the WTO to form a panel to settle this dispute. (Continues)
Emmanuel:
Targeted are income tax reductions and refunds, value-added tax (VAT) exemptions, tariff exemptions, discounted lending rates, and exemptions from mandatory worker benefit contributions said to be made available to Chinese and foreign-invested enterprises (FIEs) satisfying certain export performance requirements. Also cited are income tax and VAT refunds given to companies that purchase Chinese-made equipment and accessories. See 4.2.1 (b) and (c) here for sample benefits to FIEs--many of which have ties to China’s neighbors. USTR charges that these are in violation of WTO stipulations on Subsidies and Countervailing Measures for they “require recipients to meet certain export targets, or to use domestic goods instead of imported goods.” Until the actual complaint is posted on the WTO site, there is still uncertainty over the specific products and measures in question (hat tip: International Economic Law blog).
The USTR charges that while it has repeatedly mentioned its concerns to them, Chinese officials have not taken steps to remove these measures. The timing of this episode attracts interest: Why is it only now that the US is acting despite knowing about these measures before? The Financial Times suggests that the administration is responding to pressure from the Democratic congressional majority over the bilateral trade imbalance, and that Bush is keen on winning congressional support for extending his fast-track authority in trade negotiations once it expires at midyear. This authority might be crucial if an international agreement is made during the restarted WTO Doha development round. I would add that election season 2008 is near, hence these efforts to garner political support--especially in the rust belt. If this matter is favorably resolved before reaching the adjudication stage, Republicans should gain clout with those in the manufacturing sector. Even if the case does reach the adjudication stage, it should still give Republicans political capital for they can point to “doing something” about China as proceedings will be ongoing right in the middle of the campaign season. It is a heads-up move politically.
Some of these export-promotion measures are considerable, like export-tax rebates. In 1994, China introduced a national value-added tax system that had a main rate of 17%, with a rate of 13% applied to basic goods. Exporters were able to claim rebates of 17% and 13% respectively, effectively negating the VAT. While these rebates were reduced twice to 10% and 6% by 1996, the onset of the Asian financial crisis meant that China had to find a way of maintaining its export competitiveness. Though it did not devalue the yuan for doing so would have likely caused doubts over the soundness of China’s finances at a time when other Asian economies were in crisis, China did increase the rates of these rebates to compensate. According to official statistics, the average rebate rate reached 14.75% by 1999 and 15.6% by 2002. More recently, China has lowered rebates on export goods from high-pollution industries like steel and textiles. While the rates on these rebates have bounced around, the amount spent has increased in recent years together with China’s export growth. Below is a chart depicting what China has spent on these export-tax rebates in dollar terms using year-end conversion rates:
In 2005, these export-tax rebates totaled $41.78B. Official statistics put the H1 2006 figure at about $27B. From 2001 to 2005, these rebates were somewhere between 4.5% and 5.6% of the value of Chinese exports. It is important to point out that export-tax rebates are not as clearly in violation of WTO rules as some of the other measures previously noted. If demonstrated, two things should help them be deemed legal. First, these rebates should not exceed the amount paid to domestic tax authorities. If the VAT rate paid is 10% for example, then the rebate given should not be greater than 10%. Second, foreign firms exporting from China should also be able to claim these rebates.
Can this episode spark a trade row? China has replied that this case is “a pity.” Yet, in response, China appears amenable to concessions on steel and perhaps other products. These rebates are not cheap, either, and have accounted for between 14% and 38% of the central government’s total expenditures in past years. The government has already accumulated substantial arrears in its export-tax rebate payments. The continued use of these rebates and other measures seem to conflict as well with China’s avowed intention of transitioning to a more consumer-driven economy as government spending is directed towards promoting exports instead of creating social safety nets thought necessary in encouraging a consumer culture. As of now, the long-awaited Sino-American showdown at the Trade O.K. Corral is not yet in the cards, but we might be getting there sooner than we think.
CommentsChinese IT companies (chip makers, e.g.) seem to export their parts first to escape the VAT even if the parts are destined for domestic consumption. It works because of the zero tariff on IT products. So not all VAT rebates are necessarily export subsidies. Many companies must be using it for tax avoidance.
I came across this while reading company reports. One company reports that all parts are exported (so it does not pay VAT) even though I know their main market is inside China.Written by HZ on 2007-02-07 23:41:50A simple final sales tax seems to make a lot more sense and avoid all the complexity and administrative headaches associated with VAT. Domestic equipment makers are at a distinctive disadvantage if they have to pay VAT but importers don't have to and import tariff is lower than VAT rate. That "import substitution subsidy" isn't really a subsidy. There is more than what meets the eye.Written by HZ on 2007-02-07 23:47:29Can we be sure about the link between export rebates paid out by the government and actual exports? And therefore that a change in export rebate policy would impact exports?
http://www.atimes.com/atimes/China_Business/IA30Cb02.html
"...a considerable part of China's trade surplus is not real, but in fact comes from "fake" exports by enterprises that fraudulently obtain export rebates from the government...
...A popular practice is to export certain goods to get tax rebates and then smuggle or import the goods back to sell in the domestic market...
...This "mis-invoicing" was commonplace among Chinese importers over the last decade, but back then it was a way of getting money out of China...Now it is the other way around...
...the actual trade surplus in 2005 was probably only $35 billion after the deduction of false export claims and concealed non-trade capital inflow, which could total $67 billion..."
If there is any truth to this, it might throw some light on why some numbers just do not add up. Any sanctions or tariffs the US imposes will be ineffective anyway, as goods made in China will be labelled "made in Indonesia" and shipped with papers stating they originate from Indonesia, without actually having entered an Indonesian port.Written by Indonesia on 2007-02-07 23:48:53I believe there is little chance that a panel will be formed in this case. In addition, I see this as a profoundly defensive rather than offensive move by the USTR.
1) The Administration is clearly trying to take momentum away from the Democratic Congress on trade issues in general (e.g. see recent Bush and Bernanke offensive). Specifically, this case can be viewed as a quasi-substitute to prevent anti-China legislation such that would change existing US trade laws to allow CVD complaints against non-market economies. The Bush administration is clearly looking to buy time rather than punish China. Protectionism, particularly in the US, is usually an administrative rather than a legislative phenomenon. The biggest threat is not the enactment of Smoot-Hawley (or Schumer Graham), but opening the administrative floodgates to US industry complaints.
2)The USTR has limited options to bring good cases. After contemplating several high profile cases (including IPR), the USTR has found that American firms are profoundly unwilling to help bring cases against the Chinese that might result in retribution from the Chinese government. This moves to the point that anti-dumping and other trade laws have not sufficiently evolved with changes in the global economy. From a diplomatic perspective, this fits the US strategy of treating China as a "stakeholder."
3) Will this case spark a trade row? Probably not. This case is actually a positive for the Chinese in that provides political cover to undertake reforms that the government WANTS to do but is unable to do strong interest group opposition. Keep in mind, some of the USTR case/evidence is essentially taken from a document that China itself submitted to the WTO last year regarding remaining subsidies in their domestic system. In the end, it seems that both sides win.
The Bush administration is credited with “doing something” while actually not really doing much of anything. It also stems off harmful legislation for a period of time (even better if a panel forms which takes even more time). The Chinese get more time and cover to perform reforms. The real question is how long will this placate Democrats, my guess is not long when they finally wake up.Written by Anonymous on 2007-02-07 23:55:22HZ,
I saw your comments after posting mine. Your statement about the company that exports 100% despite being mainly a domestic player would be consistent with the Asia Times paper.
Also: Who pays? The government. Who benefits? All factories, whether they actually export or not. Who owns the factories? Probably people who are well connected to the government. So why on earth would they decide to stop the flow of export rebates funds into their own pockets???Written by Indonesia on 2007-02-07 23:59:27one question being if it may all be adding up to a spectacular abuse and misallocation of resources:
"water shortages could be the bottleneck to China's economic and social development." http://news.bbc.co.uk/2/hi/business/6336079.stmWritten by Guest on 2007-02-08 07:14:37
Export tax rebates are hardly the direct taxpayer subsidies that the US government pays inefficient sugar cane farmers in Alabama and Louisiana. Moreover, export tax rebates are NOT illegal under WTO trade regulations. The European Union provides export tax rebates for the luxury German automobiles exported and high-value added Airbus transport aircraft, but the Chinese get hammered for providing export tax rebates in the labor-intensive textile industry that has long ago migrated to developing nations. The bottom line: The USTR has absolutely no case whatsoever in this politically motivated lawsuit.Written by Dave Chiang on 2007-02-08 08:34:39HZ: The annual amount of export-tax rebates recorded can be found on the website of the Chinese tax authorities. Look at the last line (after 17.) for 2005 and H1 2006. On this website you can find data that goes back to 1994--when China adopted the VAT system. Note that while China has granted export-tax rebates since 1981, the amount spent on these rebates has gone up markedly since the VAT system was adopted.
Read this too if you are interested in how export-tax rebates are calculated.
As you pointed out on the other blog, VAT rebate is not illegal per se. Similar to a state in U.S. not charging sales tax for export from that particular state. The other name for VAT is sales tax (except VAT is collected incrementally), and use tax.
How is your estimate of VAT rebate derived? I suppose that only applies to the value added by the final exporter -- ie an upstream part maker is not rebated for its value add -- so you can't simply multiply the export value by the VAT rate, in which case the estimated number seems rather big.
But I agree that it makes no sense for China to subsidize export.