China is in serious violation of its World Trade Organization (WTO) commitments by levying a 17 percent "value added tax" (VAT) on foreign semiconductor and integrated circuits products, but offering a rebate for domestic products.

The U.S. Special Trade Representative should bring immediate action against China in the WTO to demand the elimination of the discriminatory tax and rebate structures and require full compensation of exporters whose products have been taxed at the higher rate. 

A Discriminatory Tax to Support China's Defense Sector

China has been a member of the WTO for little over a year, and already is in serious violation by levying these discriminatory taxes on an important class of imported goods.

Last week, the World Semiconductor Council and the U.S. Semiconductor Industry Association (SIA) registered a formal complaint. Under this new post-WTO tax regime, China has a 17 percent VAT on foreign semiconductors but only taxes integrated circuits manufactured within China at 6 percent, while integrated circuit designs developed in the country are taxed at only 3 percent.

The purpose of this tax is transparent.  China seeks to force the world's most advanced semiconductor fabrication companies to invest billions of dollars in China -- both in chip manufacturing and chip design.  Without the tax, it would make no economic sense for foreign firms to set up semiconductor production lines (called "fabs") or design houses in China because these are highly capital-intensive ventures that take little advantage of China's low wage structure. 

Integrated circuit components are high-value, low-weight, durable and very transportable commodities.  They can be air-shipped quickly to customers across the globe from a central fabrication plant.  Taiwan built up its semiconductor-manufacturing infrastructure over the past two decades on this very model.  Indeed, upon receiving the "tape-out" blueprints of a chip design from a customer in, say, California or Osaka, Taiwan's "foundry" fabs (or even those in South Korea or Singapore) can turn out thousands of customized IC chips in a matter of days, and airship them back across the ocean for assembly into whatever advanced-technology product the customer produces.

China's rapidly expanding semiconductor demand is well suited to this business model because Taiwan is so close.  Manufacturers in China have easy and quick access to foreign-built semiconductors flown in from overseas.  But China's central government is not satisfied with this. 

According to a report last year from the U.S. Congress's General Accounting Office, Beijing wants to force foreign firms to set up billion-dollar fabs inside China to support its defense technology sector.  At present, Motorola and Japan's NEC have waferfab lines in China, but foreign operators supervise them.  This enables those production lines to gain export-license access to American-made semiconductor manufacturing equipment that would be denied to Chinese government-owned -- especially Chinese defense industry-owned -- firms.

In order to gain access to advanced technology for its military, China is now pressuring foreign firms to grant increasing levels of Chinese-government oversight of domestic semiconductor operations.  In some cases, the Chinese government has apparently set up "false foreign devil" waferfabs ostensibly under Taiwanese direction, but owned by the Chinese government and is outfitting them with state-of-the-art imported chip-making machinery. 

There can be no doubt that China is using illicit "value added taxes" and "rebates" to discourage the importation of finished IC chips from abroad in order to build up a domestic semiconductor industry for which there is no economic need. 

U.S. Should Re-examine Export Control Policies
The U.S. Special Trade Representative should bring immediate action against China in the WTO to demand the elimination of the discriminatory tax and rebate structures and require full compensation of exporters whose products have been taxed at the higher rate.  The U.S. Commerce Department and the Pentagon must re-examine the state of U.S. export control policies and coordinate with friends and allies to ensure that advanced defense-critical technologies are not being released to IC production lines located in China. 

Congress also has a role to play in overseeing the national security implications of China's discriminatory policies: To ensure that American high-tech firms are not forced by Chinese taxation and other non-tariff barriers to invest in China's semiconductor and advanced-technology sectors.