Brussels, March 1 (Reuters): The European Union imposed sanctions on the United States for the first time on Monday as a dispute over tax breaks for US firms turned into a trade battle that could cost US exporters $300 million this year.

The lower tax rates on exports by firms, including Boeing and Microsoft, have been judged an illegal subsidy by the World Trade Organisation (WTO), which ruled the EU could respond by imposing up to $4 billion in sanctions a year on US goods.

But European Trade Commissioner Pascal Lamy decided to apply only gradual pressure by phasing in the measures, which will hit a wide range of goods, including textiles, jewellery and toys.

The sanctions are intended to prod the US Congress quickly to replace the tax breaks with measures in line with WTO rules.

“The name of the game is not retaliation, it is compliance,” said a spokeswoman for Lamy.

“The day the new measures are passed by the Congress, we will stop the sanctions.”

The sanctions start at $16 million as an extra 5 per cent duty on selected US goods in March. They are due to rise 1 per cent a month to $315 million in 2004 and $666 million if they run throughout 2005.

Based on the full $4 billion, the main sector to be hit would be the US jewellery at an estimated $1.43 billion.

Officials have tried to play down the impact of the trade row, the first time since the WTO was created in 1995 that the EU has retaliated on US goods.

“This is not the beginning of a trade war. WTO disputes are all part of the system,” one Washington official told reporters ahead of the March 1 deadline for the sanctions to apply.

But EU firms have expressed worries over the escalation of a dispute that could increase costs just as the economy revives.

Lamy has said sanctions should be seen in the light of daily transatlantic trade of $1 billion, and the EU has coped since 1999 with more than $100 million of imposed US sanctions a year in a fight over beef.

The dollar’s weakness is likely to lessen the pain for US exporters and the administration of President George W. Bush has pressured Congress to change the disputed tax laws.

“The retaliatory tariffs on American exports pose a threat to... growth and may retard the creation of jobs in certain sectors of the economy,” treasury secretary John Snow, commerce secretary Don Evans and US trade representative Robert Zoellick said in a letter to Congress last week.

The US Senate is expected to begin debate next week on a bill to repeal the provisions and use an estimated $50 billion in savings to lower the corporate tax rate for manufacturers.

The outlook for legislation in the House of Representatives is less certain, but industry officials hope lawmakers can agree a bill in the coming months to send to Bush.

EU-US trade ties have seen bruising battles recently. The EU came close to sanctions after Bush ordered a rise in steel import duties, but the duties were ended in time.