The Trump Administration alerted Congress in 2018 of its intention to negotiate a free trade agreement with the United Kingdom at such time as the U.K. withdrew from the European Union. Letters of October 16, 2018 to Congress, https://ustr.gov/sites/default/files/20181017004930805-3.pdf. In February 2019, USTR released its intended negotiating objectives for an FTA with the U.K. See https://ustr.gov/sites/default/files/Summary_of_U.S.-UK_Negotiating_Objectives.pdf. While a working group has been in place for the last several years between the two countries, with the U.K. withdrawal from the EU last month, there is significant interest in both countries in moving the talks forward.

With the U.K. leaving the EU, the U.K. is obviously anxious to secure trading relationships with its major trading partners on its own terms as quickly as possible. While the U.K. has announced continuation of FTAs under the same terms as the EU had negotiated with a few countries, 2020 will see great focus on its negotiations with the EU and with the United States.

For the United States, a free trade agreement with the United Kingdom would not only be important as the U.K. is the fifth largest economy in the world, the 8th largest source of imports into the U.S. and fifth largest export market for the U.S., but also an important opportunity to address challenges in the trading relationship that were not addressable while the U.K. was part of the EU. To the extent that the U.S. seeks to address such issues, doing so ahead of any EU-U.K. agreement will probably be critical to ensuring the U.K. can commit to regulatory and other issues meeting U.S. needs or objectives.

In the WTO last week, the EU had its 14th Trade Policy Review. On February 18th, the United States outlined a series of concerns with EU policy that will certainly be a focus of U.S. negotiations with the U.K. to see such policies are not continued by the U.K. in its independent trade policy. Excerpts from Ambassador Dennis Shea’s comments are provided below reviewing U.S. concerns with the EU trade policies:

“First, the United States remains deeply concerned by unjustified EU barriers to our agricultural exports. Recently, dozens of WTO Members have expressed concerns in the SPS and TBT Committees and in the Council on Trade in Goods regarding EU pesticide policy, which restricts trade without scientific justification or benefit to human health.

“Beyond pesticides, we are equally troubled by the EU’s unjustified non-tariff barriers that impede the use of modern agricultural tools and technologies such as biotechnology, veterinary drugs and pathogen reduction treatments, all of which help to ensure a safe, sustainable food supply.

“More disturbing, the EU is foisting its misguided domestic policy on other countries through regional trade agreements and development assistance initiatives. This approach will have global consequences, including impeding the ability of least developed and African countries to modernize their agricultural systems to feed a booming population and develop their
economies.

“With respect to dairy, despite efforts to reform EU policy by eliminating milk production quotas, the Commission’s market intervention actions during the 2016-2019 period interfered with market adjustments and had a serious impact on the price of skim milk powder on the world market. These market interventions reduced export revenue and domestic milk prices for the United States and other dairy-exporting countries. As it considers further changes in its Common Agricultural Policy, we encourage the EU to avoid programs that distort world markets to the detriment of other exporters.

“Second, as we regularly raise in the TBT Committee and the Council on Trade in Goods, the United States also has concerns about the proliferation of EU TBT measures that affect U.S. manufacturers and producers in a wide range of sectors, including medical devices, chemicals and high tech products.

“These barriers derive in large part from the EU’s TBT policies that result in a closed, regional approach that discriminates against U.S. – and other foreign – manufacturers by relying on regional, instead of international standards, and by requiring local testing of products.

‘Even worse, the EU exports trade-restrictive elements of its own standards and regulatory system to countries with which it negotiates trade preferences and to which it provides technical assistance. The EU also presses these policies in international organizations, such as the International Laboratory Accreditation Cooperation (ILAC), which will undermine those organizations and the benefits they have for the international trading system.

“Third, we are deeply troubled that EU member states’ fisheries subsidy policy is heading in the wrong direction. Last year, the European Parliament not only voted to reintroduce subsidies for fishing vessel construction, but also increased fisheries funding by more than one billion euros annually– totaling close to 8 billion euros over a six-year period and placing the EU in the #2 slot as the world’s largest subsidizer of its fisheries.
European Council Ministers then upped the ante by proposing to subsidize as much as half the value of these new fishing vessels. This is particularly concerning. Just as the WTO is seeking to finalize a multilateral agreement to constrain capacity-enhancing fisheries subsidies, the EU is not only proposing ways to maintain and even increase these subsidies without limits, but also suggesting that the WTO should explicitly label them as ‘green.’

“Likewise, the EU’s newly announced ‘green deal’ is also cause for serious concern. The combination of legislative and nonlegislative so-called ‘green’ policy initiatives creates a strong risk of additional trade restrictions in the EU market. These policies, while citing laudable environmental objectives, risk disrupting global supply chains.

“Fourth, regarding services, the United States is extremely disappointed that a number of governments in the EU have adopted or are moving closer to adopting unilateral digital services taxes (“DSTs”) that appear designed to tax revenues earned by particular U.S.-based firms.

“The United States conducted a formal investigation of the French DST, and we concluded that this measure is discriminatory due to the selection of services covered and the revenue thresholds for applicability. It also contravenes a number of prevailing international tax principles.

“Countries that enact a unilateral DST are jeopardizing the OECD effort to reach consensus on a multilateral solution for new international tax rules. We strongly support the OECD process. But in the event a country moves outside the OECD process and unilaterally imposes a DST, the United States will take all appropriate action to defend our interests.”

https://geneva.usmission.gov/2020/02/18/u-s-statement-at-the-eu-trade-policy-review/

Addressing these types of issues are part of the U.S. negotiating objective with the U.K. and are important for U.S. agricultural and industrial sectors and for U.S. digital service providers.

Outside of agriculture where existing tariffs can be significant and products can be subject to tariff rate quotas, most of the additional liberalization will be through addressing non-tariff barriers, addressing regulatory differences through mutual recognition agreements or harmonization, by further liberalization in services and adopting agreed rules on e-commerce.

For example, U.S. imports from the U.K. in 2019 resulted in duties being collected in the amount of $628.6 million, roughly 1% on imports for consumption of $63.2 billion. Close to 40% of the ordinary customs duties collected on imports from the U.K. are on autos entered under HS 8703, a category of sensitivity to the United States based on its Section 232 investigation in 2018.

Based on the EU statements on negotiations with the U.K. going forward, any desire by the U.K. to not comply with a wide range of EU regulatory regimes will likely lead to a different type of free trade agreement being offered to the U.K. than a broad FTA. The U.K.’s size and proximity have led members of the EU Parliament and the EC Trade Commissioner to indicate that FTA models such as those between Canada and the EU will not be available to the U.K. absent an acceptance of core regulatory approaches used by the EU. At the same time, the U.K. has indicated that it does not intend to comply with all EU regulations going forward. The interplay between the two sets of negotiations (EU-U.K.; U.S.-U.K.) will present challenges and opportunities for both the U.K. and the United States.

An Opportunity for the United States Not Likely to Be Pursued

USTR’s February 2019 summary of negotiating objectives for talks with the United Kingdom did not include any objectives addressing treatment of border taxes. In the Bipartisan Congressional Trade Priorities and Accountability Act of 2015, there was a principal negotiating objective on border taxes which focuses on negotiations at the World Trade Organization:

“(18) BORDER TAXES.—The principal negotiating objective of the United States regarding border taxes is to obtain a revision of the rules of the World Trade Organization with respect to the treatment of border adjustments for internal taxes to redress the disadvantage to countries relying primarily on direct taxes for revenue rather than indirect taxes.”

19 U.S.C. 4201(b)(18).

While the U.S. has state sales taxes, the United Kingdom, like nearly every other major country in the world relies heavily on value added taxes (VAT) (or their counterpart) on goods and services. Such VATs are 20% in the U.K. on most goods, are rebated on export from the U.K. and are assessed on imports upon entry into the U.K. The United States is one of the few major countries without a national value added tax. In the early days of the GATT, it was agreed that the rebate of indirect taxes like VATs or sales taxes was not an actionable subsidy but that the rebate of direct taxes (income taxes) was an actionable subsidy. This differentiation has discriminated against countries with a direct tax orientation and eventually licensed massive subsidies that cannot be addressed for countries principally relying on indirect taxes. The assessment of the tax on importation also has imports effectively covering a significant part of the importing country’s revenue needs. The Johnson Administration back in the 1960s made a major effort to get GATT Contracting Parties to eliminate this bias in its rules but without success. Every trade promotion/fast track legislation enacted since then has included a negotiating objective similar to what is contained in 19 U.S.C. 4201(b)(18).

The United States could pursue with the United Kingdom a change in the U.K. system, not to eliminate the use of VATs or to reduce the VAT rate, but rather to introduce flexibility in how it applies VAT to imported goods from other countries and what, if any VAT it rebates on export. For example, it could apply its VAT up to the level of indirect taxes rebated by the exporting country and it could limit the rebate to the level of indirect taxes that would be imposed on importation by third countries. Such a change in approach could be a template for other trade negotiations by the United States.

The U.S. could also have the correction of the distinction between direct and indirect taxes addressed as part of the current WTO reform discussions, but has not to date introduced such a proposal in Geneva.

The history of the distinction between direct and indirect taxes and the efforts of the United States to address the distortions to U.S. trade was compiled in a paper prepared for the U.S.-China Economic and Security Commission back in 2007.

TLAG-Report-Discrimination-on-Taxation

If the Administration is serious about addressing the massive trade deficit, within the trade arena, the damage to the U.S. from the distinction between direct and indirect taxes if addressed would likely have a far larger effect on U.S. trade flows than other actions that have been taken by the Administration.

Conclusion

Both the U.K. and the U.S. want a trade deal now that the U.K. has withdrawn from the EU. Each is an important trading partner to the other, and both want to advance from the relationship when the U.K. was part of the EU.

While the agenda presented by USTR in February 2019 addresses many of the core issues included in 19 U.S.C. 4201, the U.K. will be struggling between its desire to be free from EU regulations, the importance of the EU market to U.K. exporters, and its desire to do a comprehensive agreement with the U.S. which will want the U.K. to modify its approach from past EU approaches on a number of important issues. The possibility of achieving a good agreement in a reasonably short period of time is certainly there although the time to conclude a deal with the EU for the U.K. will be a challenge to what it can or will do with the U.S. The sooner the U.S. concludes a deal with the U.K., the more likely that the U.K. will accept obligations on regulatory and other issues important to the U.S. Such obligations will be contrary to EU existing regulatory approaches. The EU has made clear that it will be pushing the U.K. to maintain EU regulatory policies for the best EU-UK deal.

Moreover, the U.S. has not teed up what is arguably the most important trade liberalization issue between the U.S. and the U.K. (and with any country with a significant VAT tax), and based on its actions to date is unlikely to do so either bilaterally or within the WTO.

Achieving reciprocal trade involves ensuring that all forms of discrimination are addressed along with internal domestic policies that don’t support global competitiveness. While economists argue that the discrimination based on the direct-indirect tax difference in treatment is corrected by currency movements, observers of the mounting U.S. deficit during a period when more and more countries have shifted to indirect taxes and many have increased their indirect tax rates would argue the theory doesn’t hold up.

So look for 2020 to be an interesting year in our trade relationship with the United Kingdom.