A first round of WTO dispute settlement consultations last week appears to have produced little conciliation on what the US and Mexico allege to be a range of Chinese investment and tax rules that illegally encourage industrial exports and discriminate against imported goods.

When initiating dispute proceedings against China on 2 February (WT/DS358/1), the US pointed to a large number of tax schemes and financial regulations that it argued had the effect of providing "refunds, reductions or exemption to enterprises in China on the condition that those enterprises purchase domestic over imported goods, or on the condition that those enterprises meet certain export performance criteria" (see BRIDGES Weekly, 7 February 2007). Subsidies linked to either objective are prohibited by Article 3 of the Agreement on Subsidies and Countervailing Measures. The US said that such subsidies also violated China's accession commitments, as well as WTO rules on taxation and investment-related measures. Mexico filed an identical complaint on 28 February.

Following the first consultation meeting on 20 March, the Chinese mission to the WTO issued a press release stating that the complainants had "misunderstandings" about the country's investment and taxation regimes. It said that some of the targeted "so-called 'subsidies' programmes" had already ceased to exist. For instance, the country's central bank had terminated a regulation that gave advantageous loans to large exporters.

The US trade representative's office has said that many manufacturing sectors in China benefit from WTO-inconsistent support, particularly steel, information technology, clothing, wood, and paper.

China also claimed that some of the alleged subsidy programmes had long been on its domestic tax reform agenda, pointing to the major overhaul of corporate income taxation approved by lawmakers in Beijing on 16 March. That law ended almost thirty years of favourable tax rates for foreign firms, replacing them with a single rate of 25 percent for corporations both foreign and domestic. Prior to this, the income of foreign companies had been taxed at 15 percent, even though Chinese institutions could face rates twice as high.

Sources say that during the consultations, the US and Mexico argued that China had not provided sufficient evidence to demonstrate that the programmes in question had indeed been abandoned. Furthermore, they suggested that the pace and coverage of the reforms was not clear; for instance, it appeared possible that some targeted measures would be 'grandfathered', leaving existing practice effectively untouched by reform.

In spite of the "misunderstandings," China's statement said that "all parties took the views that the consultations proved to be helpful and contributed to the better understanding of the concerns of all parties concerned."

It is not clear whether the two complainant delegations in the case shared that view. Sources report that they were pleased to send China a clear signal that WTO-inconsistent subsidies would not be tolerated. The lack of clear answers may prompt Washington and Mexico City to seek the establishment of a panel, thus formalising the dispute.

The US is facing heavy domestic pressure to take a tough line on trade with Beijing. Many members of the new Democratic majority in Congress feel that unfair practices in China, including subsidies, are partly responsible for the US' ever-growing trade deficit. On 27 March, Democratic leaders in the House committee with jurisdiction over trade outlined a series of principles for future US policy; these included taking "action to address massive Chinese subsidies and IPR [intellectual property rights] violations." They also urged the presidential administration to be more proactive at filing legal disputes at the WTO.

If the complainants choose not to drop the China subsidies case, they will be able to request a dispute settlement panel as early as April, though nothing would keep them from continuing consultations past that time.

The EU, Japan and Australia have joined the dispute as third parties.

ICTSD reporting; "China to end tax breaks for foreign firms," LA TIMES, 17 March 2007.