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What's a tariff and why do I care?

What exactly are tariffs?

Tariffs are taxes imposed on imported goods. In simple terms, tariffs generally make it more expensive to buy imported products, while benefiting domestic companies in those same industries.

Who pays tariffs?

Tariffs are typically paid by the importer purchasing the products. Tariffs levied by the United States are paid to U.S. Customs at our nation’s ports of entry, with the proceeds going to the U.S. Treasury. Tariffs imposed on U.S. goods by other countries are paid by the companies importing them.

What is a trade agreement?

A trade agreement is the contractual arrangement that results after countries negotiate with each other to set tariffs. Trade agreements can be either bilateral (between two countries) or multilateral (involving multiple countries) are the ways countries negotiate with each other to set tariffs.

How do tariffs work?

Let’s say an American retailer buys 100 pairs of shoes from a Chinese manufacturer for $20 each, or $2,000 in total. If the U.S. levies a 25% tariff on shoes, the retailer pays $500 to U.S. Customs, raising its total cost from $2,000 to $2,500.

On the other hand, if a Canadian grocery supplier imports $3,000 worth of yogurt from the U.S., a 10% tariff levied by Canada means that the supplier pays $300 to the Canadian government, in addition to the $3,000 it pays for the U.S. supplier for the yogurt.

In rare cases, the importer and exporter may make a private agreement for the exporter to pay the tariff. In most cases, the importer absorbs the tariff cost, while passing it on to the consumer, which raises the product’s cost.

What is the purpose of tariffs?

Nations have historically levied tariffs for two reasons: to raise revenue for the government and to protect domestic companies or industries from foreign competition.

Before the U.S. established a federal income tax in 1913, tariffs provided an important source of government funding. They accounted for 30% of federal revenue in 1912. After World War II, the use of tariffs to raise revenue declined dramatically and in 1962 the Trade Expansion Act was passed. Bolstered by this new law, the formation of the World Trade Organization (WTO) in 1995, and international trade agreements, governments significantly lowered tariffs to promote international trade. Tariffs now generate about 1% of federal revenue .

Why is tariff use growing?

The U.S. Government has implemented significant changes in U.S. trade policy, specifically with China, with the stated intention of reducing the nation’s trade deficit and raising revenue through tariffs.

A key strategy has been to shift from multilateral free trade agreements to bilateral trade deals that help cement ties and secure preferential deals with strategically important trading partners.

This led to the U.S. withdrawing from the Trans-Pacific Partnership and replacing the North American Free Trade Agreement (NAFTA) with the yet-to-be-ratified United States–Mexico–Canada Agreement (USMCA).

Under the new U.S. trade policy, the government has levied tariffs that penalize foreign countries that subsidize their exporters or engage in other trade practices the Administration deems unfair. Canada, Mexico, European Union nations and China have all responded to new U.S. tariffs with retaliatory tariffs of their own. Steel, aluminum, lumber and several hundred categories of goods imported from China, valued at hundreds of billions of dollars, are impacted by this new trade policy, and disputes on unfair trade practices are heard and decided by the WTO. China’s tariffs on U.S. goods most directly affect the auto industry, the tech industry, and the U.S. agricultural industry.

How do you know if a tariff has been imposed on a product?

Tariffs are imposed on specific product classifications. The U.S. International Trade Commission’s Harmonized Tariff Schedule includes 10-digit classification code numbers for more than 17,000 products, ranging from harps to umbrellas. U.S. Customs and Border Protection is the only agency that can provide legally binding advice or rulings on classification of imports.

What kinds of businesses do tariffs impact most?

The first tariffs ever imposed by the U.S. Government in 17891 focused on commodities like steel and lumber – goods that U.S. companies use to make finished products. Many impacted companies looked for ways to absorb these additional costs in an effort to minimize price increases to consumers.

The more recent $300 billion in tariffs expected to take effect December 15, 2019 will levy a 10 percent tariff on Chinese products and cover a broader spectrum of low-margin consumer goods. They are expected to impact a wider range of companies of all sizes and more directly affect consumers in 2020 and beyond.

What can businesses do minimize the impact of this new trade policy?

For businesses that operate on thin margins, new U.S. and foreign retaliatory tariffs have the potential to push profitable operations into the red.

Farmers are among those who have already been caught in the middle. On one hand, they face higher equipment prices tied to U.S. tariffs on imported steel and aluminum. On the other hand, they have seen export demand for their soybeans and other crops decline, as a result of retaliatory tariffs from China and other countries.

While the U.S. government has provided farmers some financial relief in the form of farm subsidies, most businesses must tailor their own tariff management strategy. Consider a retailer that stocks everything from sweaters and toasters to luggage and toys, much of which is made in China and has been hit with a new tariff up to 25%. This added cost cannot be quickly or easily passed on to customers. Prices are often set well in advance and can last for six months or longer before renegotiated.

Businesses facing uncertain tariff circumstances have several options, including:

Switching suppliers – A business might look into switching to U.S. suppliers or those in non-tariffed countries like Vietnam and Indonesia. In some cases, they might also look for alternate products made of materials not impacted by the tariffs. The risk: costs could go up or quality down, and a switch takes time, sometimes years.

Renegotiating agreements – After taking a close look at the direct and indirect ways they are impacted by tariffs, businesses can seek to renegotiate supplier agreements. A business that locks into favorable deals with its suppliers now can avoid cost increases down the road, should tariffs stay in place or increase further. A domestic business that gains a competitive edge as a result of a tariff, however, may want the flexibility to raise prices to down the road and choose to avoid long-term commitments.

Adjusting prices – Passing along 100% of a U.S. tariff to consumers will likely result in lower sales. But if a business can absorb part of the cost, it may be able to implement incremental price increases to recoup the remainder.

Stockpiling impacted goods – If a business knows that goods it buys are – or will be -- impacted by tariffs, it can consider building inventory before the price increases. That could include purchasing smartphones, computers or other electronics that have been targeted for future tariffs. Loading up on inventory can have a large impact on a company’s cash flow and increase storage, warehousing and other costs.

Reducing other expenses – Whatever else it does, a business must stay focused on its profit margin. Faced with increasing costs, it may need to reduce staff, tighten non-tariffed inventory or seek other ways to manage cash flow.

Communicating with trade experts – If a business doesn’t have a relationship with trusted professionals who understand U.S. trade policy and its implications, now is a good time to build one. Commerce Bank can provide contacts and resources who can provide guidance on changing trade policies.

When will the tariffs be lifted?

No one knows, but indicators show they will be with us for the foreseeable future. The uncertainty now governing global trade making it especially hard to predict the long-term impacts of the evolving global landscape.

Also See:

1Tariff Act of 1789; Source: