The WTO ruled against China because it taxed imported car parts at the same rate it taxed imported foreign cars, something it had promised not to do on entry into the WTO. The result of that taxation was to encourage auto part manufacturing to relocate in China. (Remember Delphi?)
In ruling against China, the WTO declared that China was giving preferential treatment to auto parts made in China (no equivalent tax on them.)
China’s car-making market has grown rapidly and it is now third in auto sales after the U.S. and Japan. However, manufacturers have to source 40 percent of parts by value in China to avoid the tax, and foreign makers of parts have only recently started to keep pace with the overall growth in the Chinese market.
China’s full-year vehicle sales in 2007 rose 22 percent to 8.8 million units, according to the government-sanctioned China Association of Automobile Manufacturers
Of course, China offered other incentives for sourcing inside China: Preferential tax treatment to foreign manufacturers. They were (until recently) taxed at half the rate as indigenous firms. (And sometimes, at zero rate.)
Quite clearly, China has kept its focus on becoming the world’s exporter, using taxation gimmicks and cheap labor as the lure. This latest WTO ruling is certainly welcome. But, because China gave preferential tax treatment to foreign firms inside China, no violation occurred on that front. The WTO permits that kind of inequality.
Indeed, foreign firms relocating to China are still given a 5-year tax holiday, especially for foreign firms higher in the value chain, as well as preferential tax rates in “some regions.” (See here. Foreign taxation policies, while of little concern to many, still plays an important part in our trade deficit.
Lest anyone suggest that we should lower U.S. corporate taxation, consider the consequences if we followed China’s example: Tax holidays and/or lower taxation on foreign firms in the U.S. –and conversely, higher taxation on our own firms. Of course, to complement this policy, we should also relax minimum wage and labor standards. (Well, I guess we do that with our immigration non-policy. Chuckle.)
The ideological center of this problem is the WTO principle that foreign firms shall not be disadvantaged. In short, a country is allowed to place its own firms and its own populace at a significant disadvantage. How we deal with the full scope of China’s taxation policy is important. The WTO cannot, ideologically, deal with it. How do we deal with a country that uses its taxation policy to lure our firms by disadvantaging its own?
Is our response tax rebates, better education, rebuilding our infrastructure. Are these answers? Or do we pin our hopes on China’s notoriously weak regulatory process, all those lead-laced Mattel toys, for example?
Apart from the current violation, we do not seem to have the framework with which to address the problem. Should the WTO expand its “fairness” principle to include indigenous firms so that they cannot be placed at an unfair advantage to foreign firms in terms of taxation? Just a thought.