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May 21, 2019

Tackling Tariffs: A Deep Dive Into How Tariffs Affect You and Your Business

Tariffs are Taxes

One of the favored talking points of President Trump is the trade deficit between the U.S. and China. And one of his favored solutions to remediate this imbalance is tariffs. Tariffs are a source of revenue for the national fiscal budget. But this budgetary focus understates how they operate as a tax on goods. It also understates the complications involved in the imposition and administration of tariffs. 

How Tariffs Operate

The first point of order is how tariffs operate as a tax. Under Title 19 of the Code of Federal Regulations, Section 141.1, tariffs are imposed on importers and are remitted by importers to the U.S. Customs and Border Protection office (Customs). Tariffs are not imposed on exporters, a point National Economic Council Director Larry Kudlow acknowledged recently in an interview. For instance, a U.S. importer of Chinese goods must remit import duties to Customs; the tariff is not levied against the Chinese exporter.

In some cases, the party bearing the ultimate cost of this tax might not be the importer. To remain price competitive, the exporter could decide to lower the selling price for its exports in order to offset the importer’s added tax costs, so that the ultimate consumer price remains unaffected. This is seldom the case, however, as demonstrated by two recent studies (which can be read here and here).

Without a price concession from the exporter, the importer must either absorb the cost of the import tax or pass it on to the consumer.  The importer most often will choose to pass the cost onto the consumer. This increase could appear in a couple of different ways. The first path is the more obvious, in that the price of a good or raw material is increased by the price of the tariff. In the other less obvious path, importers look for alternative materials or goods (including from domestic sources) that may be more expensive, inferior in quality, or both.

As can be seen in either case, the real economic cost of an import tax is ultimately borne by the consumer. In fact, one of the aforementioned studies concluded that the 2018 tariffs cost each American an average of $213 over the first 9 months of 2018. Extrapolated over the full year, this totals approximately $86 billion of increased costs on American consumers. For comparison, individuals received an estimated $75 billion tax cut in 2018 based on the first projections for the revenue effect of the new tax law commonly known as the Tax Cuts and Jobs Act (TCJA). Thus, the economic costs of the 2018 tariffs more than offset the individual tax cuts from the TCJA for 2018.

How Import Taxes Are Administered

The administration of import taxes is often likened to that of a sales tax. Generally, a sales tax is based upon the price (value) of the item and is thus an ad valorem tax. Also, sales taxes are broadly applicable and are levied at varying tax rates that depend on the product category. But the comparison between an import tax and a sales tax vastly understates the level of complexity inherit in the tariff system. Even the comparison of both as an ad valorem tax is incomplete.

There are actually four different ways of applying a tariff to an item, and only one of these four ways is value-based (other methods reference an item’s quantity or weight). Furthermore, there are approximately 13,500 possible rates that can apply depending on the nature of the item and the country that it is coming from.

And the rates are not the only complicating factor. For industrial tariffs alone, the Office of the United States Trade Representative dictates that there are approximately 5,000 different commodity groups. These commodity groups break down into 11,000 subgroups and these subgroups break down into nearly 20,000 smaller subgroups. U.S. Customs and Border Protection has this to say about the level of complexity:

Experts spend years learning how to properly classify an item in order to determine its correct duty rate. For instance, you might want to know the rate of duty of a wool suit. A classification specialist will need to know, does it have darts? Did the wool come from Israel or another country that qualifies for duty-free treatment for certain of its products? Where was the suit assembled, does it have any synthetic fibers in the lining?

And it is the responsibility of the importer to ensure that the imported item is properly classified. Documentation is necessary to show that the proper classification processes were followed; an importer cannot simply rely on the exporter’s classification. Penalties for improper classification can be imposed on the importer for up to the monetary value of the item. Further, importers are responsible for requesting tariff exemptions on the items they import.

To be granted an exemption, the importer must demonstrate that there is either insufficient quality or quantity of the item available via a U.S. source, or that there is a national security need for the imported item. The nature of a national security need generally renders that category non-applicable. To be eligible under the other category, an importer generally must obtain detailed information regarding the available supply of similar U.S. items, and the importer will have to analyze the quality of similar items as well. An importer’s simple cost comparisons to U.S.-made items will be unlikely to succeed.

Workarounds for Tariffs

In sum, these administrative burdens on the importer add additional costs that must be performed internally or outsourced.

Sometimes, the burden can encourage creative workarounds. For instance, one tariff that is dubbed “the chicken tax” levies a 25% import tax on U.S. importers of light trucks, which was enacted in response to foreign tariffs on the export of U.S. chickens. The normal U.S. import tax is 2.5% on most vehicles.

To implement a workaround, companies like Mercedes build vans (classified as light trucks under the applicable tariff regime) in Germany and then disassemble them, ship the pieces to the U.S., and then reassemble them in the U.S. Another creative tariff workaround resulted in the Subaru Brat. This small truck (think of a miniature El Camino) had rear-facing seats added to the back so that it could be classified as a passenger vehicle instead of a truck.

Even domestic companies have gotten into the game. Ford sought a workaround from import taxes on its vans, which are made overseas, by shipping the cargo model to the U.S. with seats and rear windows installed. Thereafter, the seats are removed and the windows are replaced with metal panels.

These workarounds are not always successful or practical. For Mercedes the inefficiency led them to convert part of their U.S. manufacturing facility to make the vans locally. Subaru stopped selling the Brat in the U.S. (though admittedly for reasons that were unrelated to tariffs). And Ford’s ploy to avoid the chicken tax was ultimately a failure, with the U.S. government stating that the vehicle alterations were not enough to exempt them from the higher tax.

If They’re So Complicated, Why Use Tariffs?

Added together, the additional costs on consumers and the administrative complexity for businesses make import taxes burdensome on the American economy. But tariffs are nevertheless a negotiating tool available to the President as he navigates international trade agreements. The goal of such agreements is to offset the additional costs of import taxes by greater productivity in the U.S., or more profitable exports from the U.S.

For more information about tariffs and their impact on you or your business, please contact your local CBIZ tax professional.

2019 Business Tax Planning Supplement

Copyright © 2019, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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