As the global trade war escalates, companies are resorting to innovative strategies to navigate tariff hurdles, but at what cost?
As concerns grow over the impact of steep new tariffs on U.S. companies and consumers, attention is turning to how certain businesses try to avoid them. President Trump‘s long-threatened taxes on imports from China, Mexico, and Canada took effect recently, prompting retaliatory measures on American exports, roiling the stock market, and fueling fears of an economic downturn.
Tariffs are taxes imposed on imported and exported goods by a country.
They can be used as a trade policy tool to protect domestic industries, generate revenue, or retaliate against other countries' trade practices.
The World Trade Organization (WTO) regulates tariffs under the General Agreement on Tariffs and Trade (GATT).
According to WTO statistics, the average tariff rate among its member countries is around 2%.
However, some countries impose much higher rates, such as the United States with an average tariff rate of over 3%.
Companies have several primary methods to get around tariffs. One strategy is to lobby the government for an exemption or reprieve, as automakers did recently. Another approach is to shift sourcing from countries like Mexico and China to places like Vietnam, Malaysia, and Thailand, third-party countries not yet part of the emerging trade war.
However, some companies have turned to tariff engineering instead. This involves reclassifying or redesigning products to get into lower tariff categories. For instance, ‘Marvel successfully argued in court that X-Men action figures are non-human toys rather than dolls, nearly halving their tax rate.’ Similarly, Santa suits are more likely to be deemed duty-free ‘festive articles’ if they have Velcro closures.
Tariff engineering is a strategy used to minimize customs duties and other taxes on imported goods.
It involves optimizing the classification, valuation, and origin of products to reduce tariff liabilities.
Companies use various techniques such as product reclassification, transfer pricing, and free trade agreements to achieve this goal.
According to a study, companies that effectively implement tariff engineering can save up to 20% on their import costs.
The technique requires expertise in customs regulations, international trade laws, and supply chain management.
Tariff engineering can involve relabeling a product as something else or making changes to the product itself. One example is Converse All Star sneakers, which have a layer of fuzzy felt on the bottom, allowing them to be classified as slippers with a duty rate of 6%, compared to 20% for athletic shoes.
Columbia Sportswear adds pockets below the waistline of certain women’s shirts so that they are not technically classified as blouses. The company refers to it as a ‘ChapStick pocket.’ Ford Transit Connect, a small passenger minivan commonly used for bakery deliveries and construction crews, was characterized as a passenger vehicle to pay the lower tax rate.
However, in some cases, companies have been accused of misclassifying products to skirt taxes. For example, Ford was sued by the U.S. government for allegedly importing vans from Turkey with rows of seats in the back and claiming it as a passenger vehicle. The company agreed to a $365 million settlement in March 2024.
Tariff evasion refers to the act of intentionally misclassifying or undervaluing goods to avoid paying customs duties.
This practice can lead to significant revenue losses for governments, estimated at billions of dollars annually.
Tariff evasion often involves complex schemes, including false invoicing, misdeclaration, and cargo consolidation.
According to a study by the World Customs Organization, tariff evasion accounts for approximately 10% of global trade.
To combat this issue, many countries have implemented advanced technologies, such as artificial intelligence and big data analytics, to detect and prevent tariff evasion.
Tariff engineering is legal, but it’s not foolproof. Customs agents are tasked with spot-checking products entering the country and making sure they are classified correctly. If customs accepts the reclassification or labeling, then the company may never hear about it again.
However, if a product doesn’t appear to be what it’s labeled, it could lead to a court case at the Court of International Trade. A competing business that is paying higher tariffs for the same product could also file a suit. ‘Irwin says customs could flag products that don’t appear to be what they are labeled.’
While companies can try to minimize the impact of tariffs, much of that burden is still likely to fall to individual shoppers. ”Businesses have to make all the adjustments,’ says Douglas Irwin, an economics professor at Dartmouth University. ‘We consumers just sort of see what’s available when we get to the stores.’
