EU trade commissioner Pascal Lamy has decided to apply gradual pressure in what is being billed as a trade war with the United States, starting with a five percent duty on selected U.S. exports. He said the rates would continue to rise unless the United States changed its law. If no changes are made, the duty will reach 17 percent by March 2005.

"The EU's objective remains the withdrawal of the U.S. illegal subsidy," the European Commission said in a statement. "The EU has opted for a response which is measured, gradual, and geared towards focussing the minds of the U.S. legislators to comply."

The tariffs apply to a wide range of goods, including textiles, jewellery and toys, and could cost American exporters $300 million this year.

U.S. export tax break system the sticking point

At the heart of the dispute -- which has been simmering for years -- lies Washington's so-called Foreign Sales Corporations (FSC) scheme which can bring U.S. companies tax breaks up to 30 percent. The FSC system has benefited major companies including Microsoft.

The EU contends that the FSC system amounts to hidden government subsidies because it allows American-based companies to offer goods on foreign markets for prices significantly below those of European competitors.

The World Trade Organization (WTO) weighed in on the row and ruled in favor of the EU. The WTO originally gave the United States until Nov. 2000 to withdraw its FSC scheme. But with the United States slow to respond, the WTO last May gave the EU the go-ahead to impose duties of up to $4 billion.

Brussels adopts measured line

But Brussels opted to exercise restraint in the face of concerned European industry groups, fearing that an all-out transatlantic trade war would hurt business interests. They gave Washington up to a year to change the FSC system.

In November last year, Lamy (photo) said, "We have opted for a measured approach and have actually left the door open for U.S. action before counter-measures are to be applied in March 2004."

U.S. slow to act

U.S. officials have also insisted that laws being considered in Washington to dismantle the FSC system foresee a transition period. Several Republican lawmakers as well as the Bush administration have come up with ideas to replace the tax, but only foresee legislative action being taken in 2005.

The transition period has been rejected by the European Commission, which demands the U.S. change the system of tax breaks immediately.

No all-out transatlantic trade war

EU officials are keen to stress that the slapping down of sanctions doesn't amount to a new transatlantic trade row. They point out that the current $200 million of sanctions on U.S. goods is just a mere fraction of the original $4 billion worth of goods the EU could have hit with duties.

Europe's powerful lobby organizations are believed to be behind the EU's cautious stance on sanctions on U.S. goods. "European business does not like sanctions because they hurt interests which have nothing to do with the disputes," the business lobby UNICE wrote in a letter to Lamy in February. UNICE is also pushing Lamy to consider giving a concession to the U.S. by allowing a phase-in period for the system to replace FSC.

Other lobby groups are also concerned. "We don't welcome it's got this far but have to accept it," Claudia Wörmann, foreign trade expert at Germany's BDI federation industry told Reuters. "The point is that these sanctions are completely in line with the WTO; the EU is acting logically from a WTO point of view, but it's a shame we have got into this situation."