Order Code RS22187
Updated January 25, 2008
Brazil’s WTO Case Against the
U.S. Cotton Program: A Brief Overview
Randy Schnepf
Specialist in Agricultural Policy
Resources, Science, and Industry Division
Summary
On December 18, 2007, a World Trade Organization (WTO) compliance panel
publicly released its final report concerning U.S. compliance with a negative ruling in
a dispute settlement case (DS267) brought by Brazil against certain aspects of the U.S.
cotton program. The panel’s ruling confirmed an earlier (July 27, 2007) interim ruling
that the United States has not fully complied with a March 2005 WTO ruling against
certain U.S. cotton support programs. A U.S. appeal (if it so chooses) must occur before
the compliance panel’s ruling is adopted by the Dispute Settlement Body (i.e., within
60 days of the ruling’s release). The ruling against the United States (barring a
successful U.S. appeal) could necessitate further U.S. farm program changes or, if no
further changes are forthcoming, clear the way for Brazil to request WTO authorization
for retaliatory trade sanctions. Both the Senate- and House-passed versions of the 2007
farm bill (H.R. 2419) contain provisions to bring the export credit program into
compliance; however, neither version appears to address the serious prejudice charge
related to price-contingent subsidies.
This report provides a brief overview of Brazil’s case against the U.S. cotton
program, the evolution and current status of the case, and the potential role for Congress.
For a detailed discussion of the U.S.-Brazil WTO dispute settlement case, see CRS
Report RL32571, Brazil’s WTO Case Against the U.S. Cotton Program, by Randy
Schnepf. This report will be updated as events warrant.
Introduction
The United States is the world’s largest cotton exporter. During the 2001-2003
period, U.S. cotton exports accounted for 40% of world trade, while U.S. cotton subsidies
averaged $3 billion per year. In late 2002, Brazil — a major cotton export competitor —
expressed its growing concerns about U.S. cotton subsidies by initiating a WTO dispute
settlement case (DS267) against specific provisions of the U.S. cotton program. On
September 8, 2004, a WTO dispute settlement panel ruled against the United States on
several key issues (discussed below). This ruling was appealed by the United States, and
on March 3, 2005, a WTO Appellate Body (AB) upheld the panel’s ruling.

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In both instances the panel and the AB issued decisions against certain aspects of
U.S. cotton programs with recommendations that the offending programs either be
removed or be altered so as to remove their adverse effects. After losing its appeal, the
United States responded to the AB ruling by removing its Step 2 cotton program and by
adjusting its export credit programs. Brazil argued that these changes were insufficient
and on August 21, 2006, requested a WTO compliance panel to review the matter.
The WTO Dispute Settlement Panel’s Recommendation
In their ruling against the United States, the WTO panel and the AB identified two
subsidy types — prohibited and actionable (described below). Each subsidy involves a
different type of response and a different timetable for implementation.1 Under the
WTO’s Agreement on Agriculture, prohibited subsidies are treated with greater urgency
than actionable subsidies — in particular, they are given a shorter time frame for
compliance. For example, the AB recommended that the United States withdraw
“prohibited” subsidies by July 1, 2005, and that it remove the prejudicial effects of
“actionable” subsidies by September 21, 2005.
Prohibited Subsidies. Two programs were found to operate as prohibited
subsidies: Step 2 payments and export credit guarantees. Step 2 payments were part of
special cotton marketing provisions authorized under U.S. farm program legislation to
keep U.S. upland cotton competitive on the world market.2 Step 2 payments were made
to both exporters and domestic mill users to compensate them for their purchase of U.S.
upland cotton, which tends to be priced higher than the world market price. Step 2
payments were deemed illegal because they were paid only to users of U.S. cotton (i.e.,
they discriminated against foreign cotton by encouraging the use of domestic products
over imported products) and because they were unscheduled (i.e., export subsidies applied
to commodities not listed on a country’s WTO schedule or made in excess of the value
listed on the schedule).3
USDA’s export credit guarantee programs (GSM-102, GSM-103, and SCGP)
underwrite credit extended by private U.S. banks to approved foreign banks for purchases
of U.S. food and agricultural products by foreign buyers.4 GSM-102 covers credit terms
up to three years, while GSM-103 covered longer credit terms up to 10 years. The
Supplier Credit Guarantee Program (SCGP) insured short-term, open account financing
designed to make it easier for exporters to sell U.S. food products overseas. The WTO
panel found that all three export credit programs effectively functioned as export subsidies
because the financial benefits returned to the government by these programs failed to
1 For disputes involving prohibited (or WTO-illegal) subsidies, the prescribed remedy compliance
time is halved. For more information on WTO disputes, see CRS Report RL32014, WTO Dispute
Settlement: Status of U.S. Compliance in Pending Cases, by Jeanne Grimmett.
2 For more information on Step 2 payments, see CRS Report RL32442, Cotton Production and
Support in the United States, by Jasper Womach.
3 For more information on country schedules, see CRS Report RL32916, Agriculture in the WTO:
Policy Commitments Made Under the Agreement on Agriculture, by Randy Schnepf.
4 For information on these programs, see USDA, Foreign Agricultural Service, “Export Credit
Guarantee Programs,” at [http://www.fas.usda.gov/excredits/default.htm].

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cover their long-run operating cost. Furthermore, the panel found that this export-subsidy
aspect of export credit guarantees applies not just to cotton but to all recipient
commodities that benefit from U.S. commodity support programs. In other words, so
long as the credit guarantees act as an implicit export subsidy, only U.S. program crops
that have scheduled export subsidies are eligible for U.S. export credit guarantees.
Actionable Subsidies. Any subsidy may be challenged in the WTO (i.e., is
“actionable”) if it fulfills the WTO definition of a subsidy5 and is alleged to cause adverse
effects to the interests of other WTO members. In particular, price-contingent payments
(i.e., payments dependent on changes in current market prices) — including marketing
loan provisions, Step 2 payments, market loss payments, and counter-cyclical payments
— were identified as contributing to serious prejudice to the interests of Brazil by
depressing prices for cotton on the world market during the marketing years 1999-2002.
The panel recommended that the United States take appropriate steps to remove the
adverse effects of these subsidies or to withdraw the subsidies entirely.6
Such subsidies were previously afforded some protection under the so-called “Peace
Clause” (Article 13) of the WTO’s Agreement on Agriculture. However, the WTO panel
reviewing the U.S. cotton case found that the United States was in violation of its Peace
Clause spending limit such that Brazil’s dispute settlement case could proceed.7 The
panel ruled that neither production flexibility contract (PFC) payments under the 1996
farm bill nor direct payments (DP) under the 2002 farm bill qualify for the WTO’s green
box AMS exemption as decoupled payments due to the planting restriction on fruits,
vegetables, and wild rice on program base acres. As a result, PFC and DP payments were
counted against the U.S. Peace Clause limit.
U.S. Response to the DS Panel Ruling
On July 1, 2005, USDA instituted a temporary fix for its export credit guarantee
programs, whereby the Commodity Credit Corporation (CCC) would use a risk-based fee
structure for the GSM-102 and SCGP programs. The new structure responded to a key
finding by the WTO that the fees charged by the programs should be risk-based. User
fees for GSM-102, the primary export credit program, presently are capped at 1% of the
value of the export product (7 U.S.C. 5641). Higher fees are needed to ensure that the
financial benefits returned by these programs fully cover their long-run operating costs,
thereby eliminating their subsidy component. In addition, the CCC stopped accepting
applications for payment guarantees under GSM-103. Furthermore, both the Senate- and
House-passed versions of the 2007 farm bill (H.R. 2419) contain provisions to eliminate
the GSM-103 and SCGP programs, and to remove the 1% cap on fees that can be charged
under the GSM-102 program.8
5 As defined in Article 1 of the WTO’s Agreement on Subsidies and Countervailing Measures.
6 Report of the Panel, WTO, WT/DS267/R, para. 7.1503, p. 354.
7 For more information on the Peace Clause and its role in this dispute, see CRS Report RL32571,
Background on the U.S.-Brazil WTO Cotton Subsidy Dispute, by Randy Schnepf.
8 Section 3002, Title III, of the House-passed H.R. 2419 (July 27, 2007); and Section 3101, Title
III, of the Senate version of H.R. 2419 as passed (Dec. 14, 2007) with amendments.

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On August 1, 2006, the Step 2 cotton program, which was authorized by the 2002
farm act (P.L. 107-171; Sect. 1207), was eliminated by a provision (Sec. 1103) in the
Deficit Reduction Act of 2005 (P.L. 109-171). The Administration likely felt that
sufficient program changes had been enacted to fully comply with the “actionable
subsidies” portion of the WTO ruling. Furthermore, it is likely that the Administration
deemed that Congress would have the opportunity to make further adjustments, if needed,
when it passed new farm legislation in 2007 (as current farm law was set to expire in
2007).
Brazil Seeks $4 Billion in Retaliatory Trade Measures
According to WTO rules, trade sanctions are limited to a value not to exceed the
level of lost benefits. As the reform deadlines under the two different subsidy types
expired, Brazil first requested (July 4, 2005) authorization from the WTO to impose $3
billion in countermeasures against the prohibited U.S. subsidies. This value corresponds
to (1) Step 2 payments made in the then-most-recently-concluded marketing year
(2004/05) and (2) the total of exporter applications received under the three export credit
guarantee programs, for all unscheduled commodities and for rice, for the then-most-
recent fiscal year (2004).9 To achieve $3 billion in retaliation, Brazil proposed to suspend
tariff concessions as well as obligations under the WTO Agreement on Trade-Related
Intellectual Property Rights and the General Agreement on Trade in Services. The United
States objected to the amount of Brazil’s proposed sanctions, and requested WTO
arbitration.10 However, the United States and Brazil reached a procedural agreement
temporarily suspending arbitration proceedings concerning the prohibited subsidies.11
Second, as the September 21, 2005, deadline to address the actionable subsidy ruling
expired, Brazil charged that the United States had neither taken nor announced any
specific initiative for the price-contingent programs deemed to cause prejudicial impact
to Brazil’s trade interest. Brazil then requested authorization from the WTO to impose
countermeasures valued at $1 billion as retaliation against the actionable programs. Once
again, the United States requested WTO arbitration over the level of the proposed
sanctions.12 Again, the United States and Brazil reached a procedural agreement, thereby
temporarily suspending further retaliation proceedings on the actionable subsidies.13
Brazil Requests a Compliance Panel
Initially Brazil showed a willingness to permit the U.S. legislative process —
motivated by the 2007 expiration of U.S. farm programs and the prospects of a successful
9 For details, see CRS Report RL32014, WTO Dispute Settlement: Status of U.S. Compliance in
Pending Cases, by Jeanne J. Grimmett.
10 WTO official document WT/DS267/24, July 19, 2005. Official WTO documents are
accessible online at [http://docsonline.wto.org/gen_search.asp?searchmode=simple].
11 WT/DS267/25, August 18, 2005.
12 WT/DS267/27, October 18, 2005.
13 WT/DS267/29, December 7, 2005.

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Doha Round of trade negotiations14 — to bring U.S. farm programs into compliance with
the WTO ruling, even if this process extended well beyond the deadlines established
under the WTO dispute settlement ruling. However, on August 21, 2006, Brazil
submitted a request for a WTO compliance panel to review whether the United States had
fully complied with panel and AB rulings. The WTO’s Dispute Settlement Body (DSB)
agreed to establish a compliance panel at the September 28, 2006, DSB meeting. On July
27, 2007, the compliance panel released a confidential interim ruling to the two countries
that the United States has not fully complied with the March 2005 WTO ruling against
certain U.S. cotton support programs. On October 15, 2007, the compliance panel’s final
report was released confidentially to the U.S. and Brazilian governments and, two months
later on December 18, 2007, it was released publicly. The panel’s final ruling confirmed
the earlier interim ruling against the United States.
If the United States appeals the compliance panel’s ruling, it must do so before the
compliance panel’s ruling is adopted by the DSB (i.e., within 60 days of its release). If
appealed, an Appellate Body decision would not be likely until mid-2008. The ruling
against the United States (barring a successful U.S. appeal) could necessitate further U.S.
farm program changes or, if no further changes are forthcoming, clear the way for Brazil
to request WTO authorization for retaliatory trade sanctions. First, however, Brazil would
likely ask the WTO arbitration panel to resume its work, with a decision within 60 days,
according to the U.S.-Brazil agreement on prohibited subsidies. U.S. failure to comply
with any decision could result in WTO-sanctioned trade retaliation by Brazil against the
United States. The U.S. response to the WTO cotton ruling is being watched closely by
developing countries, particularly by a consortium of four African cotton-producing
countries that has submitted its own proposal to the WTO calling for a global agreement
to end all production-related support for cotton growers of all WTO-member countries.15
Role of Congress
When confronted with a negative WTO dispute settlement ruling, a country has
essentially five options to choose from: eliminate the subsidy; reduce the subsidy to
diminish its adverse effect; revise the program function to reduce the linkage between the
subsidy and the adverse effect (referred to as decoupling); pay a mutually acceptable
compensatory payment to offset the adverse effects of the subsidy; or suffer the
consequences of trade retaliation.
Ultimately, Congress is responsible for passing farm program legislation that
complies with U.S. commitments in international trade agreements. The United States
has already complied with at least a portion of the AB’s recommendation by eliminating
the Step 2 program. In addition, proposed provisions in the pending House and Senate
farm bills would bring the export credit program into compliance with WTO rules by
eliminating the “subsidy” component of export credit guarantees. However, neither the
House- nor the Senate-passed version of H.R. 2419 appears to address the serious
prejudice charge related to price-contingent subsidies. Instead, both the House and Senate
14 For more information and an update on the status of Doha negotiations see, CRS Report
RL33144, WTO Doha Round: The Agricultural Negotiations, by Charles Hanrahan and Randy
Schenpf.
15 For more information, see CRS Report RS21712, The African Cotton Initiative and WTO
Agriculture Negotiations, by Charles Hanrahan.

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versions of H.R. 2419 appear to offer higher levels of price and income support that could
potentially aggravate the perception (if not the reality) of “serious prejudice” in the
marketplace. Several of the proposed changes are specifically relevant to the Brazil
cotton case, but also germane to the broader issue of program vulnerability to WTO
challenge.16 For example, both House and Senate farm bill versions would:17
! extend current marketing loan provisions and the CCP program;
! raise both loan rates and target prices for several commodities, while only
lowering (marginally) the target price for upland cotton;
! offer producers the choice of revenue-based support options in lieu of
CCP (which includes significantly higher per-acre revenue guarantees for
cotton than under the current 2002 farm bill);
! change the world price used by USDA to determine cotton marketing
loan repayment rates from a Northern European price to a Far Eastern
price, which presumably would result in larger payments under the
provisions of the program; and
! create a new cotton-user payment of 4 cents per pound. (This payment
appears similar to the WTO-illegal Step 2 payment except that cotton
from all origins (not just domestic sources) is eligible for the payment.
Since the United States imports very little cotton, most payments would
still likely go to domestically sourced cotton. As a result, this subtle
technical loophole might be subject to a WTO challenge if it survives the
congressional legislative process and emerges as part of a new farm bill.)
Finally, both pending farm bill versions fail to address the issue surrounding the
disqualification of direct payments from WTO’s green box AMS exclusion as decoupled
payments due to the planting restriction on fruits, vegetables, and wild rice on program
base acres. Instead, direct payments are extended with no change to the current planting
restriction (except for a small pilot program on 10,000 acres in Indiana). This glaring
retention of the status quo has important WTO implications, as both Canada and Brazil
have recently initiated WTO cases against the United States charging that the United
States has exceeded its total AMS limit on several occasion in recent years if direct
payments are included in the AMS calculation.18
Additional uncertainty arises from the ongoing Doha Round of trade negotiations,
where a successful conclusion could potentially mitigate or end Brazil’s interest in
continuing its case against the U.S. farm programs. Both agriculture committees (House
and Senate) of the 110th Congress will likely continue to monitor developments in the
WTO cotton case and the Doha negotiations, as well as the aftermath of the compliance
panel’s final ruling.
16 For more information on this issue, see CRS Report RS22522, Potential Challenges to U.S.
Farm Subsidies in the WTO: A Brief Overview, by Randy Schnepf and Jasper Womach.
17 See CRS Report RL33934, Farm Bill Legislative Action in the 110th Congress.
18 See CRS Report RS22724, Canada’s WTO Case Against U.S. Agricultural Support: A Brief
Overview, and CRS Report RL22728, Brazil’s WTO Case Against U.S. Agricultural Support: A
Brief Overview, both by Randy Schnepf.

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