On 28 March 2024, China requested consultations with the United States regarding certain aspects of its Inflation Reduction Act (IRA). This is the latest in the ever growing list of trade disputes over green industrial policy (GIP) measures. IRA entered into force on 16 August 2022 as a key pillar of the Biden Administration’s climate agenda to accelerate the shift towards low carbon economy. It seeks to promote the development and deployment of clean technologies, inter alia, through subsidies for electric vehicles and electricity generated from renewable energy sources. China alleges that the conditions attached to the subsidies for electric vehicles and renewable energy projects are discriminatory trade measures inconsistent with international trade rules. This short piece examines China’s legal claims, the possible exceptions the US may invoke to justify its subsidies and the environmental implications of the case.
IRA: Relevant Background
Like most recent GIPs such as the European Green Deal, IRA is designed to achieve multiple public policy objectives. Such objectives range from economic and security to geopolitical and environmental protection. At the heart of IRA is the ambition to tackle climate change and spur the transition towards a low carbon economy. Towards this end, it sets out to provide an estimated over $393 billion in subsidies for the development and deployment of clean technologies. IRA is widely regarded a historic piece of climate legislation and is estimated to ‘cut US net greenhouse gas emissions down to 31% to 44% below 2005 levels in 2030’.
The most controversial aspects of IRA from an international trade perspective are related to the tax credits for clean vehicles and renewable energy projects. The clean vehicle tax credit scheme seeks to make electric vehicles (EVs) more affordable by subsidizing the purchase of both new and used vehicles. However, the EVs must meet certain requirements to qualify for the tax credits.
First, the EVs must be assembled in North America (US, Canada and Mexico). Second, certain percentage (40% by 2024 and 80% by 2026) of the critical minerals (e.g. cobalt, lithium, nickel, etc.) contained in the vehicle battery must (a) be extracted or processed in the US; (ii) be extracted or processed in a country with which the US has an FTA; or (iii) have been recycled in North America. However, a vehicle does not meet this requirement if it contains any critical minerals ‘extracted, processed, or recycled by a foreign entity of concern’. Foreign entity of concern is further defined as an entity ‘owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation…’. The list of covered nations includes countries such as China. Third, certain percentage (50% by 2024 and 100% by 2028) of the value of the battery components of the EVs must be manufactured or assembled in North America. However, a vehicle does not meet this requirement if any ‘components’ contained in its battery is ‘manufactured or assembled by a foreign entity of concern’.
The IRA tax credits for renewable energy projects are extensions and modifications of existing federal tax credit schemes for renewable energy production and investment. The most important modification is the requirement to use domestic over imported renewable energy products. Investors in renewable energy projects receive a base tax credit of 6% of the qualified investment in the energy property. Similarly, those who produce electricity from renewable energy sources receive a base production tax credit of $0.03/kW (inflation adjusted) over a 10-year period. On top of these base tax credits, IRA provides bonus tax credits for both renewable energy production and investment. However, the bonuses are contingent upon the use of domestic over imported renewable energy products. The tax credits for renewable energy production and investment increases by 10% if the domestic content requirements are met. These domestic content requirements come in two forms. First, renewable energy projects qualify for the bonus only insofar as they use 100% domestic steel and iron for construction materials. Second, a certain percentage, which varies by year and type of renewable energy project, of the components incorporated into an eligible renewable energy project must be produced in the US.
The WTO in/consistency of IRA
China alleged that IRA is inconsistent with Articles I and III:4 of the General Agreement on Tariffs and Trade (GATT), Article 2.1 and 2.2 of the Agreement on Trade-related Investment Measures (TRIMs Agreement) and Article 3(b)(1) of the Agreement on Subsidies and Countervailing Measures (SCM Agreement). These three agreements have been at the centre of previous disputes over GIPs. The EU and Japan invoked GATT Article III:4, TRIMs Article 2.1 and Article 3.1(b) of the SCM Agreement in Canada – Renewable Energy/FIT. The US invoked the GATT Article III:4 and TRIMs Article 2.1 in India – Solar Cells. India invoked GATT Article III:4, TRIMs Article 2.1 and Article 3.1.(b) of the SCM Agreement in US – Renewable Energy. The EU limited its claims to GATT Article III:4 in the now resolved UK — C.D. Local Content (EU) dispute. GATT Article I, which prohibits discrimination among like products originating in or destined for different countries, is the only new provision in the US – IRA dispute.
The jurisprudence on the consistency of discriminatory renewable energy support measures with GATT Article III:4 and TRIMs Article 2.1 is well established. WTO Panels and the Appellate Body consistently ruled that support measures that require the use of domestic over imported renewable energy products are inconsistent with GATT Article III:4 and thereby TRIMs Articles 2.1. These two provisions prohibit WTO Members from treating domestic products more favourably than like imported products. Renewable energy support measures with local/domestic content requirements run directly against these provisions by according more favourable treatment to domestically produced renewable energy products. The requirements to use domestic over imported critical minerals, battery components and renewable electricity generation equipment make IRA’s tax credits for clean vehicles and the bonus tax credits for renewable energy projects discriminatory within the meaning of GATT Article III:4 and TRIMs Article 2.1.
Article 3.1(b) of the SMA Agreement prohibits WTO Members from providing subsidies that are contingent upon the use of domestic over imported products. The only ruling on the consistency or otherwise of discriminatory renewable energy support measures with this provision comes from Canada – Renewable Energy/FIT. While the US withdrew its claims under this provision in India – Solar Cells following the Appellate Body’s ruling in Canada – Renewable Energy/FIT, the Panel exercised judicial economy not to address India’s claim under this provision in US – Renewable Energy. For a renewable energy support measure to fall under Article 3.1(b) it must constitute a ‘financial contribution’ by a government or public body that confers a ‘benefit’ to its recipient within the meaning of Article 1 of the SCM Agreement. The list of ‘financial contributions’ under Article 1.1(a)(1) includes government revenue that is otherwise due is foregone or not collected such as tax credits. There is, therefore, little doubt that IRA’s tax credit qualifies as financial contributions within the meaning of Article 1.1(a)(1)(ii). Perhaps the key issue under the SCM Agreement is whether this financial contribution has conferred a benefit to the recipient. The Appellate Body previously ruled that a benefit exists insofar as the financial contribution make the recipient better off than it would otherwise have been, absent the contribution. However, it complicated the benefit analysis in Canada Renewable Energy/FIT by introducing new and much criticized methodology that draws a distinction between financial contributions that create markets and those that support existing markets to argue that the existence of a benefit should be determined differently when the market is created by the financial contribution itself. However, this distinction is less relevant in US – IRA as the markets for both EVs and renewable electricity existed long before the introduction of IRA. Since IRA constitutes a financial contribution in existing markets the existence of a benefit will be determined based on the traditional criteria of whether the tax credits have made the recipients better off than they would otherwise have been absent the tax credits. No doubt that the tax credits have made the recipients better off than they would otherwise have been absent . Therefore, the tax credits that are contingent upon the use of domestic over imported products are import substitution subsidies inconsistent with Article 3.1(b) of the SCM Agreement. This case offers a valuable opportunity to the Panel to clarify the jurisprudence on the consistency of renewable energy local content requirements with Article 3.1(b) of the SCM Agreement. However, it is likely that the Panel will follow the US – Renewable Energy Panel and exercise judicial economy once it establishes the inconsistency of IRA with GATT Art III:4 and Art 2.1 of the TRIMs Agreement.
The aspects of IRA that China claims to be inconsistent with GATT Article I are the favourable treatment to EVs assembled in Canada and Mexico, critical minerals extracted or processed in US’s FTA partners, critical minerals recycled in Canada and Mexico, battery components manufactured or assembled in Canada and Mexico, and the exclusion of critical minerals ‘extracted, processed, or recycled’ and battery components manufactured or assembled by a foreign entity of concern. The tax credits for EVs undoubtedly provide more favourable treatment to certain WTO Members (Canada, Mexico and other US’ FTA partners) and less favourable treatment for certain WTO Members such as China inconsistently with GATT Article I. Similarly, the tax credit for renewable energy projects provide less favourable treatment to products manufactured or assembled in countries such as China. These are clear discriminatory measures inconsistent with the Most Favoured Nation principle contained in GATT Article I.
It is clear from the above brief analysis that the IRA tax credits for clean vehicles and renewable energy projects are inconsistent with the US’s obligations under the three WTO Agreements. However, the outcome of the case will depend on whether the US can successfully justify its measures under one of the various public policy exceptions such as GATT Articles XX and XXI.
Possible legal grounds to justify IRA
The respondents in the previous disputes over renewable energy support measures pursued different approaches to justifying their otherwise WTO-inconsistent measures, albeit with no success. Canada in Canada – Renewable Energy/FIT and India in India – Solar Cells unsuccessfully invoked the government procurement exception contained in GATT Article III:8(a). GATT Article III:8(a) allows governments to treat domestic products more favourably than like imported products in the process of public procurement. Canada and India argued that their renewable energy FIT programs constitute public procurements and hence they were allowed to discriminate in favour of domestic renewable electricity generation equipment. However, the WTO adjudicators rejected their arguments noting that the government procurement derogation under GATT Article III:8(a) applies only insofar as the procured and discriminated products are like products and what both Canada and India procured (renewable electricity) and discriminated against (renewable electricity generation equipment such as solar panels and wind turbines) under their FIT programs were not like products. The clarity of this jurisprudence seems to have convinced the US not to invoke GATT Article III:8(a) in US – Renewable Energy despite the similarity of the challenged measures and it is even more less likely that it will invoke this exception in US – IRA. In any case, the challenged measure in US-IRA are tax credits not government purchase of goods and services (e.g. the Indian and Canadian FIT programs) and hence are not government procurements within the meaning of GATT Article III:8.
Interestingly, none of the respondents in the previous disputes over renewable energy support measures invoked the so called ‘environmental exceptions’ contained in GATT Article XX(b) and (g). GATT Article XX(b) justifies measures necessary to protect human, animal or plant life or health, while GATT Article XX(g) justified measures relating to the conservation of exhaustible natural resources provided that the measures do not constitute an arbitrary or unjustified discrimination or a disguised restriction on international trade. The GATT Article XX jurisprudence suggests that the US may be able to establish its tax credit schemes for clean vehicles and renewable energy projects are necessary for the protection of human life and health. The main challenge here will be establishing how the discriminatory aspects (i.e. the local/domestic content requirements and the exclusion of products from certain WTO Members) are necessary to achieve this objective and most importantly, do not constitute arbitrary discrimination or disguised restriction on international trade. China, like the EU and Japan in Canada – Renewable Energy/FIT disputes, targeted its legal challenge not against the subsidy program per se but against its discriminatory aspects. In its consultations request, China underlined that it ‘strongly supports national and international efforts to reduce and mitigate the effects of climate change, including through the use of clean energy subsidies’. It has been long established that subsidies are essential to the promotion of clean technologies, which are key to tackling climate change. The challenge is therefore not establishing the necessity of the tax credits to the protection of human life or health but establishing the necessity of the discriminatory features of the tax credits for the protection of human life or health within the meaning of GATT Article XX(b). The jurisprudence suggests that this is extremely difficult and that is probably the reason why none of the respondents in the previous renewable energy subsidy disputes invoked these exceptions.
Another exception the US may invoke to justify its discriminatory tax credits is the security exception contained in GATT Article XXI. This is a broad exception that allow WTO Members to violate their GATT obligations insofar as they consider it necessary for the protection of their essential security interests. The US previously argued that the phrase ‘it considers’ in GATT Article XXI(B) makes this exception non-justiciable and self-judging, but the Panel in Russia – Traffic in Transit found that it is neither non-justiciable nor self-judging. According to the Panel, this exception must be invoked in good faith and that the conditions set out in GATT Article XXI(b)(I-iii) must be met. The US may argue that its IRA tax credits are measures taken in time of ‘emergency in international relations’ within the meaning of GATT Article XXI(b)(iii), but the finding of the Panel in US — Steel and Aluminium Products (China) suggests that the US is unlikely to succeed. The Panel underlined that an ‘emergency in international relations’ refers to ‘circumstances of a certain gravity or severity in terms of their impact on the conduct of international relations’ and rejected the US’s claim that such circumstances existed. Nothing suggests the emergence of such circumstances to allow the US to successfully invoke GATT Article XXI(b)(iii).
The GATT Articles III:8, XX and XXI exceptions are relevant only to the claims under GATT Article I, III:4 and Article 2.1 of the TRIMs Agreement. There is no environmental or any other exception for measures inconsistent with Article 3.1(b) of the SCM Agreement. The SCM Agreement had exceptions for environmental, regional and research and development related subsidies, but these exceptions expired in 1999 due to the failure of the WTO membership to agree on their extension/revision. The lack of exceptions under the SCM Agreement has created a contradiction within the WTO legal framework whereby a single measure can be justified under some agreements but not under others. The failure of the Appellate Body to complete its benefit analysis in Canada – Renewable Energy/FIT and the exercise of judicial economy by the Panel in US – Renewable Energy have so far masked this contradiction, but US – IRA may expose it.
The environmental implications of the case
The legal analysis above reveals that the US is highly likely to lose the case, but what does that mean for the environment and the energy transition? The simple answer is not much. The US will simply ignore the ruling by appealing it into the void – and the case will add to the plethora of reasons for the US’s continued blockage of the Appellate Body. The Appellate Body has been dysfunctional since November 2019 due to the refusal of the US to allow the appointment/reappointment of Appellate Body Members. While some WTO Members have formed the Multi-Party Interim Arrangement (MPIA) to fill the gap, the US has not joined the MPIA and retains its option to disregard Panel rulings by appealing them into the void. It is likely that the US will do just that in US – IRA. However, this in turn, will force China to unilaterally retaliate against US imports and further escalate the ever-growing trade war in clean technologies. Such tit-for-tat green protectionism will undermine the transition by unnecessarily increasing the cost of clean technologies and thereby slowing down their development and deployment.