would be good for re-balancing the dom estic economy and improving the quality and sustainability of growth.

China’s system of subsides is in th e process of dramatic transition. A recen t study on China’s subsidies (Wang, Yan 2007) exam ined three categories of subsidies, and found that: (1) C ategory I subsidies –including price subsidies and s upport to the state enterprises –rose in quantity, but the share in GDP has declined dramatically from a high level of 8 percent of GDP in 1985 to 0.7 perc ent in 2005. This represents a signif icant reduction in policy distortions, which may have contributed to rapid growth; (2) Among Category II -quantifiable subsidies re ported by the government to the WTO, 72 poverty reduction and the environment received greater attention in recent years. However, if one examines the duration of benefiting from subsidies and tax exemptions, exporters, foreign invested enterprises have enjoyed preferenti al tax treatment for a longer period of tim e. Enterprises and workers in the coastal regions have benefited longer than those living in inland regions; (3) The size of quantifiable subsidies seems to be comparable to those of other large developing countries, b ut the composition is a matter of concern. Category I and II subsidies rose from 131 billion Yuan in 2001 to 132 billion in 2004, but the shares in GDP declined from 1.19 percent in 2001 to 0.82 percent in 2004; (4) Many subsidies are not quantifiable. Among 80 kinds of both quantifiable and non-quantifiable subsidies, about 26 percent out of 80 seems to be discriminatory /inconsistent with WTO principles and hence, are likely to be challenged by trading partners. However, this is from an economic point of view, not from a legal perspective.

In the litera ture, it is quite clear th at the VAT tax rebate has been considered _tradeneutral_ as VAT is dei gned to tax final output, so that taxes paid on interm ediate transactions are rebated. According to Gene Grossman who analyzed the European VAT using the “destination principle” conclude d “According to current GATT rules the destination principle applies to all indirect taxes. The European VAT as adm inistered is, therefore, trade-neutral. All p roducers, whether producing for domestic sale or for export, claim credit for any taxes paid on inputs. A tax liability is calculated for domestic sales, while export sales are exem pt. This exemption is the adjustment requested by the destination principle of taxa tion. On balance, goods are e xported completely tax free. Imports are taxed, but if they are used as intermediate goods they qualify for the same tax credit as do domestically produced intermediates” (Grossman, 1980 page 126).

Nonetheless, the US government made a request to WTO for consultation regarding VAT rebates in China. The US request to the WTO for consultation stated that these measures “appear to be inconsistent with Article 3 of the SCM Agreement”. And “to the extent the measures accord im ported products treatm ent less favorab le than that accorded “like domestic products”, they appear inconsiste nt with Article III: 4 of the GATT 1994 and Article 2 of the TRIMS Agree ment” (USA, 2007). So, this debate is not going to go away.

72 People’s Republic of China, 2006. “Subsidies: New and Full Notification Pursuant to Article XVI: 1 of the GATT 1994 and Article 25 of the SCM Agreement.” WTO Doc. G/SCM/N/123/CHN, 13 April 2006.

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