WINNIPEG, Manitoba (Reuters) -Canada canceled a digital service tax on U.S. technology companies this week in order to preserve trade talks with U.S. President Donald Trump, but another irritant, in agriculture, could be a bigger thorn in the ongoing negotiations.

Analysts said ditching the digital services tax was politically easy for Prime Minister Mark Carney compared to even discussing Canada's supply management system that since the 1970s has tightly controlled supplies of dairy, eggs and poultry by restricting production and limiting imports through onerous tariffs. 

When Carney met with Trump in mid-June, he said the two leaders were aiming for a new economic agreement by July 21.

Trump, however, threatened in a Truth Social post on Friday to derail talks and impose new tariffs due to the digital service tax, which had been scheduled to take effect on Monday. 

In the same post, Trump also attacked tariffs on dairy products.

Carney and Trump both confirmed negotiations had restarted with the removal of the tax. 

"Trump is basically one Truth Social post away from creating political chaos in Canada," said Sylvain Charlebois, a food industry analyst and professor at Dalhousie University. 

Canada's supply management system was a sticking point in trade negotiations during Trump's first term, but withstood the U.S.-Mexico-Canada Agreement (USMCA) in 2020. By March in his second term, Trump threatened reciprocal U.S. tariffs on dairy due to what he called tremendously high Canadian tariffs.

The USMCA provided limited duty-free quotas for U.S. dairy products, but for anything above these levels, tariffs on specific products can exceed 200%. Washington for years has unsuccessfully challenged the way that Ottawa has allocated the USMCA dairy quotas.

ON THE TABLE?

While some said dropping the digital services tax made Canada look weak, it has not been politically explosive and the tax was a little-known measure for many Canadians.

On the other hand, parliament amended legislation shortly before starting summer break to prevent supply management from being put on the table during trade talks, with unanimous support from all political parties in the House of Commons.

Still, trade experts say the recent legislation would not stop Canada's negotiators from discussing it. 

"At the end of the day, a Canadian government is going to do what it needs to do with supply management to get a deal," said Tyler McCann, the managing director of the Canadian Agri-Food Policy Institute, who thinks many farmers have a false belief that the legislation is binding.

The U.S. Commerce Department and the White House did not immediately respond to requests for comment. A spokesperson for the U.S. ambassador in Ottawa declined to comment on trade talks.

Gabriel Brunet, spokesperson for Canada-U.S. Trade Minister Dominic LeBlanc, said in a statement the federal government "will always stand up for the Canadian dairy industry."

"Our supply management system will never be on the table," the statement said.

Canada's dairy industry is particularly influential in Ottawa, with the majority of the country's dairy farms located in the most-populous provinces of Quebec and Ontario, provinces seen as essential to winning any federal election.

Despite concessions to Trump during his first term, supply management survived the USMCA, survives within the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and operates within the Canada-EU deal, McCann noted. 

Dairy Farmers of Canada, a lobby group, said that Trump's Friday statement was "not supported by the facts," noting the U.S. dairy industry ships more American dairy products to Canada than go the other way. 

(Additional reporting by Anna Mehler Paperny; Editing by Caroline Stauffer and Marguerita Choy)

By Ed White