Does an FTA imply tax harmonization?

The European Commission is irked by Swiss tax federalism:

Canton Obwalden, in central Switzerland, slashed its corporate tax rate to just 6.6% at the start of 2006; it attracted 376 new companies in just 11 months. The European Commission has warned that this may constitute an unfair subsidy under the European Free Trade Agreement.

“Talk to any tax expert,” said Michael Reiterer, the commission’s new ambassador to Switzerland. “This is recognised as a subsidy. And there we think Switzerland should think a bit whether behaviour which is clearly outlawed in the EU is the best policy to follow in such a close relationship between two partners.” [BBC]

I am not a tax expert, but I’ll comment anyway. Here is the only article in the EEC-Switzerland FTA of 1972 pertaining to taxation:

Article 18

The contracting parties shall refrain from any measure or practice of  an internal fiscal nature establishing, whether directly or indirectly, discrimination between the products of one contracting party and like products originating in the territory of the other contracting party.
Products exported to the territory of one of the contracting parties may not benefit from repayment of internal taxation in excess of the amount of direct or indirect taxation imposed on them.

I am unable to find any literature suggesting that tax federalism has resulted in export tax rebates for firms located in particular cantons. Summaries of the policy shift (such as this one) simply describe variations in the corporate income tax rate. So I doubt that Article 18 is violated.

The European Commission appears to be arguing that another article is relevant:

On top of cut-price corporate tax for all, that vary from region to region, some cantons offer additional concessions for foreign firms that do not have direct business activities in Switzerland. 
These kind of Domiciliary foreign companies can pay no tax or just one-tenth of their regular net income in some cantons, according to the Swiss Economic Ministry.
European Commission officials allege that the practice amounts to an unfair subsidy, violating a free trade agreement between the EU and Switzerland. [Portugal News]

The 17-page document gives detailed information about the tax regimes of cantons Zug and Schwyz in central Switzerland and the privileges they give to holding companies and other firms. But the argumentation on the main issue is vague. The draft claims that these tax practices distort trade between Switzerland and the EU, and therefore contravene the bilateral free trade agreement… According to article 23 of the free trade accord, it is enough if a privilege “threatens to distort” trade. [<A href=”SwissInfo]

Here’s Article 23:

1. The following are incompatible with the proper functioning of the agreement in so far as they may affect trade between the Community and Switzerland:

i. all agreements between undertakings, decisions by associations of undertakings and concerted practices between undertakings which have as their object or effect the prevention, restriction or distortion of competition as regards the production of or trade in goods;

ii. abuse by one or more undertakings of a dominant position in the territories of the contracting parties as a whole or in a substantial part thereof;

iii. any public aid which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods.

2. Should a contracting party consider that a given practice is incompatible with this article, it may take appropriate measures under the conditions and in accordance with the procedures laid down in article 27.

I read that article as pertaining to anti-trust practices and competition policy, not tax levels or subsidization, but I have no legal training, so I hope someone from the International Economic Law and Policy Blog tackles this story.

If free trade agreements can be reinterpreted more than three decades after the fact to have behind-the-border implications such as tax harmonization, then one can only imagine the dangers associated with signing TIFAs and PTAs addressing non-trade issues today.

[Hat tip on this story: Daniel Mitchell

Classic reference on harmonization: Bhagwati & Hudec]

China’s export promotion

Emmanuel, a guest at Brad Setser’s blog, provides a primer on China’s export incentives and rebates, some of which the US will challenge at the WTO.

In the comments section, there’s a link to this interesting piece:

Li Deshui, the outspoken former chief of the National Bureau of Statistics (NBS), recently remarked that 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.

What completed the Uruguay Round?

Former Director-General of the GATT and WTO Peter Sutherland spoke yesterday about challenges to the multilateral trading system. A few highlights amongst Mr. Sutherland’s comments:

– He believes that TPA renewal under the Democratic Congress is unlikely, but an outline of a Doha round agreement must be on the table within two months for reauthorization to have any chance.
– Doha failure will accelerate bilateralism in trade, which has historically resulted in trade deals that benefit rich countries and harm poor countries.
– Bilateralism is useless to multinational corporations with supply chains spanning many countries.
– One source of Doha’s trouble is the ill-conceived launch as a “development round” with unrealistic expectations. The WTO is not a development institution, and although its mission is to create a favorable and open global trading system that is conducive to development, “trade deals can’t deliver development.” Trade liberalization favors those who trade – the rich countries.
– In regards to the WTO’s ability to do research and advocate on behalf of global trade: “The WTO’s staff is one-quarter of the World Wildlife Fund’s.”
– “Neither the outcome nor the path to it has been satisfactory.” Sutherland echoed the message of the 2005 WTO report he chaired, criticizing the Doha round approach of announcing formulaic headline goals attenuated by numerous details and caveats. He characterized the Uruguay Round as involving more pragmatic give-and-take. Sutherland defended the “green room” sessions as a means of hammering out a consensus amongst key players who could serve as “honest brokers,” arguing that LDCs’ interests largely align with those participating in the green room.
– Similarly, Sutherland emphasized the importance of senior-level negotiators doing the heavy lifting. He noted that when he became Director-General, the Uruguay Round had already suffered two near-catastrophic ministerial meetings, and that the deal was completed six months later without a ministerial meeting. Marrakesh was a coming out party.
– Sutherland also noted that trade preferences can drive countries to specialize in commodity exports in which they don’t have a comparative advantage. His example was Caribbean nations growing bananas thanks to the EU’s ACP preferences, despite Central America’s productive superiority.

During the Q&A, I asked Mr. Sutherland to identify the forces he thinks were responsible for the Uruguay Round’s successful completion. I noted that competing interpretations of that negotiating history motivate current strategies for Doha:

Some in Washington claim the strategy helped break a deadlock in the Uruguay round after the EU balked at opening its protected agricultural market. They say by threatening to turn Apec from a loose grouping of Pacific Rim economies into a rival trade bloc, the US forced the EU back to the bargaining table.
Others, however, think such claims exaggerated. Not only have Apec’s efforts to free regional trade achieved little but, they argue, the EU softened its position on farm trade in the Uruguay round only because mounting costs made reform of its common agricultural policy unavoidable.

Sutherland acknowledged that both of those forces may have played some role (EU internal politics more than the threat of APEC), but argued that individual people matter far more in the actual negotiations. He characterized the APEC narrative as “ex post facto theorizing” rather than a compelling explanation.

Sutherland’s story emphasized the role of particular negotiators and national leaders in building a consensus and hammering out controversies. Particularly amusing was a tale of fervent discussions at 2am in the green room shortly before the completion of the round, in which negotiators debated whether the word “unfair” carried appropriate legal import to be included in a paragraph on anti-dumping. The next morning, shortly before Sutherland was due to announce the round completed, the Japanese representative informed him that the ministry of foreign affairs and MITI disagreed about the text. The ensuing brinksmanship (as narrated by Sutherland) was quite entertaining (in retrospect), and thank goodness it worked out for the best, as Japan raised no objection when Sutherland gaveled the round to a close.



Sutherland’s story of the Uruguay Round’s completion was both amusing and insightful. I hope he someday puts it into print.

The Farm Bill

The Bush administration put forth its farm bill proposal last week. Alan Beattie reports:

But as far as Doha was concerned, as one experienced agricultural policymaker in Washington put it: “There is less to this than meets the eye”.

The headline totals were compatible with, but did not go beyond, the cut in annual allowable trade-distorting farm subsidies from around $22bn to around $17bn (€13bn, £8.6bn) that the Bush administration has already informally offered in the Doha round.

Subsidy programmes that support prices, because they encourage farmers to produce more and hence push down world prices, are classified as “trade-distorting” under WTO rules and are subject to stricter limits. Despite the administration’s rhetoric that it was moving from supporting farmgate prices to protecting farmers’ incomes – the so-called “revenue assurance” principle – the proposed move was modest. The “marketing loan” programme, which subsidises farmers when the prices of their produce fall below a set level, altered the calculation of the price a little to take account of actual market prices, but the change will not be dramatic.

Similarly, a controversial programme called “counter-cyclical payments”, which compensates farmers when prices are low, was adjusted to take account of national crop yields as well as prices, but the change was incremental. The US has sought to classify the counter-cyclical payments as being only somewhat distorting of trade and hence enable them to continue under a Doha deal.

Mr Johanns has repeatedly warned US farmers that the alternative to agreeing reform is to see US agricultural subsidies litigated away piece by piece under the WTO’s dispute resolution mechanism. The US is seeking a renewal of the so-called “peace clause”, under which countries agree not to bring cases against each other over farm subsidies, in the Doha negotiations, but has run into stiff opposition from Brazil, which won a landmark victory against the US cotton subsidy programme in 2005.

What's the best scope for WTO negotiations?

Former USTR Charlene Barshefsky makes the case for emphasizing sectoral agreements rather than trade rounds at the WTO:

The longer the time-spread between global developments and WTO agreements, the less relevant the WTO will become. That, to me, suggests a policy, as we pursued in the 1990’s under President Clinton, under which parties use the WTO the way it was meant to be used – and that is as a forum for continuing negotiations among the members on issues of growing concern, so as to handle these issues in a rapid and effective manner. In the 1990’s, we concluded global agreements on telecommunications market opening, financial services market opening, information technology (which brought to zero tariffs on all information technology products), and duty-free cyberspace. These were all done under WTO auspices in a sectoral fashion, in a timely way.

The last global round of trade talks was launched in 1986. This round will not conclude until year-end 2007, at the earliest. Had we not pursued these critical sectoral agreements when we did, global telecom and financial services markets would not be nearly as open to the United States as today. Would that have made make any sense, when financial services and telecom are perhaps the most critical aspects of wealth creation?

If we keep waiting for meaningful trade liberalization in large rounds, which can be held up by any issue countries wish to interpose, then we risk the future of the WTO. I believe Doha will conclude. Once it concludes, the WTO must take a hard look at its own responsiveness, and its own role as a regulator, if you will, of global economic behavior, and move toward the negotiation of agreements with the greatest salience.

The most relevant academic piece I’ve found on this topic is a chapter in Economic Development and Multilateral Trade Cooperation by Philip Levy (PDF available online). In his introduction, he writes:

What is the appropriate scope of a negotiating round? Is it generally possible to reach agreements sector by sector? If it is possible, is it advisable?

This paper will attempt to bring existing economic theory to bear on these questions. In the next section, we will review the traditional case for package deals in trade rounds, bolster that case with some theory and then challenge it with the apparent success of sectoral negotiations. We will argue that track record of the sector-by-sector approach is less attractive than it seems and that its successes may well have had negative effects on future negotiations beyond the unfortunate procedural precedent.

Pointers to additional literature on this topic would be much appreciated.

What’s the best scope for WTO negotiations?

Former USTR Charlene Barshefsky makes the case for emphasizing sectoral agreements rather than trade rounds at the WTO:

The longer the time-spread between global developments and WTO agreements, the less relevant the WTO will become. That, to me, suggests a policy, as we pursued in the 1990’s under President Clinton, under which parties use the WTO the way it was meant to be used – and that is as a forum for continuing negotiations among the members on issues of growing concern, so as to handle these issues in a rapid and effective manner. In the 1990’s, we concluded global agreements on telecommunications market opening, financial services market opening, information technology (which brought to zero tariffs on all information technology products), and duty-free cyberspace. These were all done under WTO auspices in a sectoral fashion, in a timely way.

The last global round of trade talks was launched in 1986. This round will not conclude until year-end 2007, at the earliest. Had we not pursued these critical sectoral agreements when we did, global telecom and financial services markets would not be nearly as open to the United States as today. Would that have made make any sense, when financial services and telecom are perhaps the most critical aspects of wealth creation?

If we keep waiting for meaningful trade liberalization in large rounds, which can be held up by any issue countries wish to interpose, then we risk the future of the WTO. I believe Doha will conclude. Once it concludes, the WTO must take a hard look at its own responsiveness, and its own role as a regulator, if you will, of global economic behavior, and move toward the negotiation of agreements with the greatest salience.

The most relevant academic piece I’ve found on this topic is a chapter in Economic Development and Multilateral Trade Cooperation by Philip Levy (PDF available online). In his introduction, he writes:

What is the appropriate scope of a negotiating round? Is it generally possible to reach agreements sector by sector? If it is possible, is it advisable?

This paper will attempt to bring existing economic theory to bear on these questions. In the next section, we will review the traditional case for package deals in trade rounds, bolster that case with some theory and then challenge it with the apparent success of sectoral negotiations. We will argue that track record of the sector-by-sector approach is less attractive than it seems and that its successes may well have had negative effects on future negotiations beyond the unfortunate procedural precedent.

Pointers to additional literature on this topic would be much appreciated.

Trade Liberalization and Industrial Restructuring through M&A

Today, I had the pleasure of hearing Holger Breinlich present his most recent work, which introduces new evidence about the reactions of heterogeneous firms to trade liberalization:

This paper analyzes mergers and acquisitions (M&A) as a previously neglected channel of industrial restructuring in the face of trade liberalization. Using the Canada-United States Free Trade Agreement of 1989 as a source of exogenous variation in trade barriers, I show that trade liberalization leads to a significant increase in M&A activity. I also provide evidence that resources are transferred from less to more productive firms in the process and that the magnitude of the overall transfer is quantitatively important. Taken together, these results suggest that M&As are an important alternative to the previously studied adjustment channels of firm and establishment closure and contraction.

Full paper here (pdf).