Donald J. Trump was elected the 47th President of the United States. As he characterized tariffs as a signature pillar of his trade and economic policy, increased use of tariffs appears highly likely in a second Trump Administration. Such changes could begin within his first 100 days in office (see our Insight here). While we do not purport to assess the wisdom of one policy choice over another, given the anticipated resurgence of tariffs as part of the trading landscape, it is vital that importers and U.S. purchasers be aware of the variety of available mechanisms for distributing tariff-related costs.
Unfortunately, coverage in the popular press tends to amplify characterizations of tariffs as taxes on the consumer, incorrectly implying that there is only one approach. To take a representative example, during the Presidential campaign CNN ran a piece (that cited this other CNN piece) which asserted:
Very simply: When the U.S. government decides to put a tariff (read: tax) on, say, Chinese goods, the actual money going to the U.S. Treasury comes from the American company doing the importing. And for that company to stay in business, it needs to make up that cost somewhere else, and that typically means raising prices on its consumers.
Such transactions could occur. But in an apparent effort to simplify matters, such summary explanations overlook the variety of transactions available to address tariff-related costs—several involve $0 net cost increases on the U.S. side, in which case there would be nothing additional to “pass through” to U.S consumer prices. Higher tariffs may be passed on to U.S. consumers in some circumstances, but in the real world, many times they are not.
American Companies Are Not the Only Entities that Can Import
A claim of 100% pass through to consumers presumes that “the American company {is} doing the importing.”
But under U.S. law, a non-resident foreign corporation may act as importer of record of merchandise imported into the United States. This is an important distinction because the non-resident foreign corporation pays the tariff upon importing the good. In such circumstances where the foreign party assumes the cost of the tariff, it may continue to charge U.S. consumers the same price.
This is a “real world” scenario. A foreign corporation may have several economically sound reasons for assuming the tariff burden itself, rather than raising prices for U.S. consumers. These include, for example, not wanting to lose market share or relationships with U.S. consumers, accepting lower profit margins on certain sales, and/or being able to offset tariff burdens with export subsidies from its home government.
As a simple illustration, take a foreign producer that enjoys dominant market share. A dominant supplier is not going to simply abandon its position in the market. Given the often high profitability of a dominant supplier, it could afford to maintain the prices it charges to U.S. consumers (thereby maintaining its dominant presence), while taking the cost of a newly introduced tariff out of its profit margin. Taking action to defend U.S. market share becomes even easier if, for example, that foreign producer were also dominant in its home market, thus able to leverage home market profitability to maintain its pricing and presence in the United States.
Tariffs Are Based on Import Value, Which Can Be Adjusted Downward by a Foreign Producer
Even in the scenario in which an American company were doing the importing, the conclusion that tariffs increase consumer prices presumes that the invoice price between the foreign producer and the American importer remains unchanged after imposition of the tariff.
Actual practice contradicts this assumption. For example, when the United States imposed duties on Chinese imports to counteract Chinese intellectual property abuses, Chinese average import values started to decrease. This generally-observed decrease in import values reflects a choice made by at least some Chinese foreign manufacturers to reduce export prices to maintain market share with the American importer.
To illustrate, consider a pair of sneakers that a Chinese producer invoiced at $100 and for which the American importer paid $100 before the tariff. Then, after the imposition of a 25% sneaker tariff, the Chinese producer reduced its sneakers’ import value from $100 to $80. The American importer thus paid $80 to the Chinese producer and $20 (25% on $80) to the U.S. Treasury, for a continued total out-of-pocket cost of $100. Because the American importer’s total costs were identical with and without the tariff, the tariff contributed zero additional net cost burden to be passed on to the end consumer. The Chinese producer, however, received less remuneration for the good after imposition of the tariff. Again, in this scenario, one can accurately say that tariff-related costs are borne by a foreign party. Literally, the American importer does “pay” the tariff, but the amount of that payment is offset by the Chinese producer’s reduction of its export price.
Regular Duties Permit Foreign Producer Reimbursement Payments
A conclusion that tariff costs are passed through to U.S. consumers also presumes that the foreign producer does not reimburse the American importer for the duty outlay. Duty reimbursement involves the American importer paying the U.S. Treasury in the first instance and the foreign producer thereafter directly reimbursing the American importer with a cash payment. Here, as with the examples above, the entity in the foreign country ultimately bears the cost of the tariff.
Real World Transactions Involve Business Judgments
What economists (and journalists reporting on basic economic theory) fail to account for in simplified, cause-and-effect descriptions of the impact of tariffs upon consumer prices is human behavior. The foregoing examples provide a sense of the variety of lawful options that exist for offshoring, eliminating, or substantially reducing the cost of tariffs and any burden on U.S. consumers.
One caveat bears mentioning. The strategies above to offshore the impact of tariffs only work for regular Customs duties, which include most favored nation duties as well as those imposed pursuant to, for example, Sections 201 and 301 of the Trade Act of 1974 and Section 232 of the Trade Expansion Act of 1962. In circumstances where unfair trade behavior has been found to occur (i.e., foreign producer dumping and/or government subsidization has caused injury to U.S. producers) and the duty is specifically calculated to offset injurious subsidization and/or dumped prices, U.S. law limits foreign producers in the strategies they can deploy to reduce tariff impact other than raising price. For example, any direct or indirect reimbursement strategy involving antidumping or countervailing duties is unlawful and can result in the doubling of those duties. This means that a foreign producer may not either reduce the price to offshore the tariff impact or directly provide payment to the American importer. Nor can the foreign producer lower its export price. Doing so would result in greater dumping being found and increased tariffs unless the foreign producer also lowers its home market prices, which is generally economically infeasible for an extended period.
As President-elect Trump has indicated that his administration would again emphasize tariffs as a tool in the trade policy toolkit, it is essential that companies impacted by international trade understand how to navigate rapidly shifting currents of tariff policy. Cassidy Levy Kent’s experienced trade professionals can assist companies to understand how tariff policy impacts their supply chains and develop solutions to advance their business objectives.