Inflation Reduction Act Knifes The Multilateral Trading System. Here’s what USTR Needs To Do.

The multilateral trading system, birthed on October 30, 1947, was unceremoniously knifed and left for dead by President Biden’s signing of the Inflation Reduction Act. This is an unprecedented move by the United States in our seventy-five year history as part of that system. Retaliation will come from much of the world. Here is what that will look like, and how the Administration should respond.

Background: What Is “The Multilateral Trading System”?

When people say “the multilateral trading system”, they’re referring to the General Agreement on Tariffs and Trade (GATT), along with a global agreement on intellectual property (TRIPS) and several dozen other lesser agreements. These agreements are overseen by the WTO in Geneva and constitute a “single undertaking”. “Single undertaking” means the agreements are a package deal: a nation must agree to all the responsibilities of all the agreements to get the benefits (chiefly, ultra low tariffs to developed-nation markets). The GATT is the most significant and oldest of these multilateral agreements, as it sets “Most Favored Nation” (MFN) bound tariff rates for every country. Bound tariff rates are like a price ceiling: a promise that you won’t charge more for a given product. Of the 164 WTO Members, the United States is capped with the lowest bound tariff rates, a paltry 3.4 percent average.

This is because rather than pursue something approaching tariff reciprocity in the GATT, the United States chose instead during the 1980s and 1990s to marry the GATT and TRIPS as a single undertaking. TRIPS requires all nations to enforce 20-year patent terms and 50-year copyright terms, among many other rules. Rights for IP holders oversees were prioritized over domestic production in United States trade policy during the second half of the twentieth century. See CPA’s introduction to the GATT for more.

The Inflation Reduction Act, however, signals a sea change away from the “IP rights abroad” era. No Congress has ever legislated such violence to the multilateral trading system as the 117th did with the Inflation Reduction Act.

This is welcome news, as U.S. obligations under the current multilateral system are economic suicide. For example, CPA has for years called on Congress to stop extending $7,500 credits to every Made-in-China electric car that arrives in our ports, as WTO rules require. The Inflation Reduction Act finally does that.

The remainder of this article explains how the multilateral system’s core has been knifed, what will happen next, and how the Administration should respond to preserve protection for domestic production without running afoul of the multilateral system, assuming they are unwilling to exit the WTO:

How The Inflation Reduction Act’s Promotion of Clean Tech Dealt A Mortal Wound To The WTO

The GATT’s MFN and National Treatment Obligations

Ask any trade lawyer: the two core central commitments of the WTO’s multilateral trading system are the GATT’s MFN and National Treatment obligations.

Here, reproduced in full, is the first paragraph of the first article to the GATT, the “Most Favored Nation” obligation (emphasis added in bold):

With respect to customs duties and charges of any kind imposed on or in connection with importation or exportation or imposed on the international transfer of payments for imports or exports, and with respect to the method of levying such duties and charges, and with respect to all rules and formalities in connection with importation and exportation, and with respect to all matters referred to in paragraphs 2 and 4 of Article III, any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties.

The reference to Article III in that text is the reference to the GATT’s “National Treatment” obligation. This is a centuries old concept that means once an importer has paid their tariff to import a product, that product should be treated the same by the host country’s laws and taxes.

Article III, incorporated in the above, explicitly commands that WTO members’ tax codes “should not be applied to imported or domestic products so as to afford protection to domestic production.

(For those curious, ‘Buy American’ laws were always allowed. Procurement is the one notable exception to National Treatment, because with procurement the government is in the role of a buyer in the market, not a regulator.)

The Inflation Reduction Act’s Violations of the GATT’s Two Core Principles in the Promotion of Clean Energy

On electric vehicles and clean power generation equipment, the Inflation Reduction Act does precisely what the GATT commands shall not be done: using the tax code to afford protection to domestic production.

Domestic Content Requirement for Clean Energy Equipment:

The Act amends existing clean energy tax credits, codified at Section 45 and 48 of the Internal Revenue Code, to include domestic content ‘bonuses’. An additional two clean energy credits are created with similar domestic content bonuses.

The changes to the Section 48 Investment Tax Credit are instructive:

  • Before: consumers received a 26% tax credit for the installation of a roof top solar system.
  • Now: consumers receive a 30% tax credit for the installation of a rooftop solar system, and an additional 10% for a 40% total if the solar panels consist of forty percent domestic content.

So going forward, if you have $20,000 you want to put towards rooftop solar, the IRS will give you a tax credit of $6,000 if the solar panels are imported, or $8,000 if the solar panels meet domestic content requirements.

Put differently, the long-standing Section 48 credit poses an effective ten percent tariff on solar module imports.

The Treasury Department still has to write the guidelines for the new law, so we don’t have details on how the 40% will be calculated.

Electric Vehicles

For over a decade, consumers received a $7,500 tax credit from the IRS after purchasing an electric vehicle. It didn’t matter where the car was made. Made-in-China Polestar electric cars, a brand owned by China’s Geely Group, began deliveries in 2021 in the United States. Polestar scaled up rapidly in 2022, even in spite of the additional 25% tariff on cars from China (for a total 27.5% tariff) imposed in 2018. Polestar cars became a regular sight in many U.S. metros in 2022. Polestar even signed a commitment to provide Hertz with 65,000 cars over the next five years.

The Inflation Reduction Act ends this economic suicide. Now, to get the full $7,500 credit, the car has to:

  1. Have final assembly in North America; and
  2. 40% of the critical minerals in the battery must be sourced from the United States, or one of the 20 countries with whom we have an FTA. This 40% increases to 50% in 2024, 60% in 2025, 70% in 2026 and 80% in 2027.

The Treasury Department published more details alongside President Biden’s signing of the Act. The Energy Department also published an initial list of vehicles it expects to meet domestic content criteria.

This is unprecedented in our 75 years of GATT membership. As with the clean energy credit, this is effectively the same as legislating a $7,500 tariff on cars from Europe and Asia. It is a total and complete WTO violation, without even invoking a rationale that could theoretically satisfy some GATT defense, like national security.

In addition, from a trade lawyer’s perspective, preserving national treatment for our FTA partners (for the critical minerals requirement), but not other WTO Members, is an explicit rejection of the core of the multilateral system.

Surprising Support From Traditionally Pro-Multilateral Voices

The Business Roundtable is an association of the biggest corporations in America, and is staunchly supportive of strengthening the multilateral system. Thus it was surprising to see its current Chair, Mary Barra, CEO of General Motors, come out in support of the Inflation Reduction Act. Autoblog noted the development with an article titled “Biden bill compels Barra to put GM before Business Roundtable“. Ford also supported the law.

Last month, we wrote that it was noteworthy that the Government of Canada expressed enthusiasm for the new domestic content criteria. This may seem unsurprising given that Canada will continue to have all obligations honored under both the WTO and USMCA, but it nonetheless marks a major shift in Canadian federal policy, which for decades has been a staunch defender of the multilateral trade system. Simply remaining silent on the new credit would have been the traditionally expected response. Not active celebration.

Asia and Europe Will Now Retaliate

European Commission spokesperson Miriam Garcia Ferrer said “we continue to urge the United States to remove these discriminatory elements from the bill and ensure that it is fully compliant with the WTO.” South Korea’s Trade Minister Ahn Duk-geun joined in the criticism, as has Japan. Politco reported that USTR “shrugged off” criticism, and Ambassador Tai has celebrated the legislation.

In the very near future, expect a WTO complaint filed by the European Union at a minimum, and likely joined by Korea and Japan. These countries’ car companies have undoubtedly been prejudiced. For example, among the top ten selling electric vehicles in the United States are the Audi e-Tron, Porsche Taycan, and Hyundai Kona EV, all of which are assembled in Europe (for the American market). All of these vehicles will lose their current eligibility for the $7,500 credit on January 1, 2023. Meanwhile, electric vehicles assembled in the United States, including all of Tesla’s models and the Chevy Bolt, will regain access to the credit (they had exhausted the old credit’s cap of 200,000 sales, and thus lost eligibility in 2020). This is a profound shakeup to the vehicle market in the United States.

Europe will win their WTO lawsuit. While the WTO Appellate Body remains defunct, WTO Dispute Panels are still convening and issuing judgments (so-called “Panel Reports”). With a victory in hand – assuming Europe waits that long – they will implement retaliatory tariffs. When a WTO country wins a WTO lawsuit and the respondent country doesn’t comply, the WTO authorizes the complainant country to issue retaliatory tariffs.

The U.S. and Europe had long maintained WTO-authorized retaliatory tariffs against each other as they each won/lost, in part, a long standing Airbus-Boeing WTO dispute. And in June 2018, in response to President Trump’s national security tariffs imposed on aluminum and steel imports, the EU imposed retaliatory tariffs of 25 percent on U.S. agricultural products, including whiskies, corn, and processed fruits and vegetables.

A fresh trade war with Europe was unexpected for this Administration. Ambassador Tai, in her first year in the role, resolved both of the above trade fights with Europe.

America’s Options In Responding To Retaliation

There are three ‘reactive’ options and one proactive option to respond.

The first reactive option is to do nothing: the United States could simply accept retaliatory tariffs in response. But this seems unlikely, as other nations have the breadth to design their retaliatory tariffs to inflict maximum political pain.

The second reactive option would be to just exit the WTO: the President has authority to withdraw from the WTO, even without Congressional action, but this too seems politically unlikely.

The third reactive option is also the politically easiest route: comply with the WTO Panel Report when it is issued. This would require removing all the domestic content requirements. It would guarantee that China rapidly displaced our domestic auto industry, and would be an unconscionable disaster. Unfortunately it is also precisely the type of policy ‘correction’ traditionally advocated for by groups like the Business Roundtable.

America’s Best Option To Fight For Made-in-USA While Remaining Part of the WTO

There is one other option to fend off retaliatory tariffs, but it requires proactive efforts on the part of USTR, which should begin immediately.

The main reason that, year after year, a smaller percentage of cars driven on American roads are actually made-in-America is because we bound ourselves under the GATT to a paltry 2.5% tariff on cars. (Worth noting Europe maintained a 10% tariff on cars as its GATT-binding, and we have a 3:1 trade deficit in cars with them. Europe sent us 765,269 cars in 2021, we only sent them 289,885). Likewise, our once vibrant ecosystem of domestic solar panel assembly was mostly lost to imports because our GATT-bound tariff rate on solar modules is zero percent. A zero-perfect GATT-bound tariff on industrial products is actually the norm for the United States, not the exception. When it comes to imports, we are essentially an open borders nation with few exceptions. We’re the dumping ground of the world.

Here’s the thing: WTO rules do not force us to remain at the bottom of the pack. GATT Article XXVIII allows nations to renegotiate their tariffs. We can boost ourselves from 3.4% to 34% on average, if we want (and we should! We could eliminate personal income tax for the bottom 90%, for example, while creating 10 million new jobs.)

Many things have lined up in our favor to make this approach a no-brainer.

First, we already have bilateral FTAs with most of our significant trade partners, with the notable exceptions of Europe and China. For FTA countries, they need not be affected, as our FTAs contain their own set of tariff commitments independent of the GATT.

With China, since 2018 we’ve mutually given up caring about our tariff-obligations vis-a-vis each other. The WTO has held both the United States and China in violation of its tariff commitments ever since President Trump initiated the Section 301 process and China retaliated. So that trade relationship is already outside the WTO orbit. And we’ll get to Europe in a minute.

Second, the GATT Article XXVIII’s rules for renegotiation play to our favor. The rules don’t force you to renegotiate for all 160+ WTO Members. Rather, for each product, you negotiate chiefly with the country that is currently your biggest supplier of that product, and the GATT/WTO country with whom you initially negotiated that tariff concession. Overwhelmingly then, our counterparties will either be 1) a country with whom we have an FTA; 2) China; or 3) Europe. (CPA has a PDF here with more information on this process, and why USTR should invoke it).

Countries with whom we have an FTA should not complain in Geneva during this renegotiation: the value of their FTA with the United States will increase exponentially. They should just go along with it, even celebrate it, much as Canada has just done with our new effective $7,500 tariff on overseas cars.

Third, with Europe, we could negotiate a parallel bilateral tariff agreement (essentially an FTA, but we need not seek to reduce tariffs further, it could even be a status quo tariff agreement).

If a counter-party nation isn’t Europe, China, or an existing FTA country, then it’s likely a beneficiary of one of our trade preference programs that cover at least 120+ developing nations. In the programs (primarily, the Generalized System of Preferences), we unilaterally waive tariffs ostensibly to help the other country develop. Powerhouse nations like Brazil, Indonesia, and Thailand are current beneficiaries. These nations are thus not well positioned to give us grief in Geneva for raising our bound tariff rates, as we are free to terminate their tariff preference beneficiary status at any time.

Tariffs Are Better Than Messing With The Tax Code

With a bound-tariff rate average closer to India’s, we will have infinitely more latitude to bring back domestic production. (See our article looking at India’s adept use of tariffs.) And it’s much better than messing around with the tax code. National Treatment is a good principle. With tariffs, you can control the amount of imports without creating compliance costs for the internal market. Filing tax returns is already far too complicated, and trying to incentivize domestic production with tax credits further complicates tax compliance. For vehicles, it is still workable, largely because every single car has a unique Vehicle Identification Number (‘VIN’). Indeed, Treasury is making a VIN-lookup tool so that consumers can verify whether a particular car satisfies the requirement. Without this, it’d be impossible for consumers to know, as the same model of vehicle is often made here and elsewhere. The Dodge Ram, for example, is made in both Michigan and Mexico. Policy makers will find that using the tax code to promote domestic manufacturing is fraught with compliance challenges, putting aside it being a total violation of the WTO.

And even with vehicles, the tax credit will lead to tax nightmares for individual Americans. For example, consumers can elect to receive the tax credit at the point of sale, bringing the price down by $7,500. But when it comes to file their taxes (potentially over a year later; e.g. a car bought in January 2023 with the credit, and 2023 taxes due April 2024), if the tax payer doesn’t have $7,500 in federal income tax liability, then they will find themselves hit with a nasty surprise in taxes owed.

Pivoting to tariffs is much more efficient. They’re easier on the home market because they keep the market loose and dynamic. And you can have tariffs and still remain in the multilateral system, if that’s what you want!

Final Thought: Automobile Industry Illustrates Problems Of Rules-Based Trade; Need to Move To Managed-Trade

In an October 2021 interview, Ambassador Tai perfectly described why America is done with rules-based trade:

I think that when you talk about managed trade, just to break it down, it is a different model for managing a trade relationship than the model that we’ve pursued before, which has been, you know, let’s seek market access and then, you know, let the chips fall where they may.

“Market access” is how trade lawyers refer to tariff commitments. Her “letting the chips fall where they may” is exactly correct: we’d lower tariffs, and then accept the results of subsequent shifts in production under some ideological notion that we can or should “compete” with the world, where workers make 1/10th or less of workers here.

Rules-based trade is antagonistic and creates international tension. As we inevitably lost jobs and factories, we’d accuse other nations of “cheating”. Undoubtedly, “cheating” is rampant, but rules-based trade inhibits solving the irritant while encouraging ongoing international acrimony.

Rules-based trade isn’t a good idea even for allied, developed democracies. When we signed the U.S.-Korea Free Trade Agreement (“KorUS”) in 2007, the perception was that U.S.-made cars (which typically had bigger engines and were less efficient than Korean cars) did not sell well in Korea due to their taxes on engine size. So in KorUS’ National Treatment chapter, we wrote in a unilateral obligation on Korea to ease up on their engine displacement taxes (KorUS Art. 2.12). That didn’t work. Korea continued to send us more than 10 cars for every 1 car we sent them. Dissatisfied, the Trump Administration acted to preserve our 25% tariff on trucks (one of those rare exceptions to us being a global dumping round!) until 2041 to limit further damage. Also in that KorUS renegotiation, we took an important first baby-step to pivoting towards managed trade: Korea promised that at least 50,000 U.S.-made vehicles annually could skip Korean safety standards and use American standards instead. The 2018 KorUS renegotiation also included a further loosening of Korean environmental regulations in the hopes of accommodating more U.S. exports.

None of this worked though. Korea still sends us more than ten times the number of cars we send them:

  • U.S. Passenger Vehicle Imports from Korea in 2021: 831,090
  • U.S. Passenger Vehicle Exports to Korea in 2021: 77,515

Now, we look like jerks. Korea accommodated our rules-based trade requests to ease up on their sovereign prerogative to manage environmental and safety standards for cars. We didn’t get the outcome we’d hoped, so now we just blew up the deal, stripping their EV exports of the $7,500 credit and denying them in the future while extending them to North American assembly. Officials in Korea’s Ministry of Trade (MOTIE) are surely, rightfully, indignant.

Sure, it’s possible Korea substituted the rules they withdrew for other, sneaky rules or maneuvers to thwarts U.S. exports. But what are we going to do, keep yelling at them and calling them cheaters while we lose domestic market share year after year? And are we even sure that’s it? Perhaps Koreans just like supporting their home brands more than American do?

With managed trade, we avoid this hot mess. We set expectations on volumes, like sovereigns that mutually respect each other, and go from there. No name calling, no insinuations. Here’s an example of how it could work: 50,000 vehicles tariff-free each way. Their OEMs send may choose to send us fuel-sippers, our OEMs may choose to send them rugged SUVs. Whatever. Both countries’ OEMs could discover that there’s a viable market for their product, and then make the investments necessary to supply the other country’s market from within. We get all the benefits of competition, without the downsides of hollowing out our domestic base.

Hopefully Ambassador Tai can get the support she needs from the Biden Administration to fully embrace the switch to managed trade. Waiting around for Europe and Korea to sue us is not a good path. Let’s get the Art. XXVIII renegotiation started in Geneva, and start talking with Europe, Korea, and Japan about new, managed trade agreements that set clear expectations on volumes and balance without purporting to re-write their domestic laws. This is the way.


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