In a globalized economy, tariffs play a pivotal role in shaping international trade dynamics. They are a key tool for influencing prices, controlling the cost of goods sold, and driving the strategic responses of businesses to trade policies. This paper explores what tariffs are, how they are enforced in the United States, and examines how companies may respond to significant increases in tariffs on imported goods, particularly by adjusting their manufacturing and assembly locations.
The basics
Tariffs are taxes or duties imposed by a government on imported goods with the primary aim of making foreign products more expensive, thereby encouraging consumers to opt for domestic alternatives. Governments use tariffs for several reasons. First, tariffs have historically served as a major source of revenue, especially before the introduction of income taxes. Second, tariffs are a powerful tool in trade policy, offering protection to domestic industries by making imported goods less competitive. Finally, tariffs can be part of an economic strategy to nurture and protect emerging sectors, giving them time to grow and compete on a global scale.
There are several forms of tariffs. One common form is the ad valorem tariff, which is calculated as a percentage of the value of the imported goods. For example, a 10% ad valorem tariff on an imported car valued at $20,000 would result in a $2,000 tax. Another type is the specific tariff, which is levied as a fixed fee per unit, such as $1 per kilogram of an imported product. Some tariffs are compound, combining both ad valorem and specific rates to further influence pricing.
Historically, tariffs have played a prominent role in shaping U.S. economic policies. The U.S. government has relied on tariffs since the Tariff Act of 1789, which helped fund the fledgling government. The Smoot-Hawley Tariff of 1930 is another example; it raised tariffs on thousands of imported goods to protect American businesses during the Great Depression. In recent years, the U.S. has reintroduced tariffs on steel and aluminum, citing the need to protect domestic industries and reduce dependence on foreign sources, especially from countries viewed as potential strategic competitors.
Enforcement
The federal government has several means of enacting tariffs, primarily through legislative and executive powers. Congress holds the constitutional authority to regulate international trade, which includes the power to impose tariffs. This legislative process often involves debates in Congress, where tariffs may be included as part of broader trade agreements or as separate tariff-specific legislation. When Congress enacts a new tariff, it generally specifies the type, amount, and target goods or sectors, aiming to align with broader national interests, such as supporting domestic employment or balancing trade deficits.
Under certain laws, the president also has the power to impose tariffs without needing congressional approval, which allows for swift action in response to emerging trade issues or perceived threats. For instance, Section 232 of the Trade Expansion Act of 1962 permits the president to impose tariffs for reasons of national security, such as protecting critical industries like steel that are deemed essential for defense. Section 301 of the Trade Act of 1974 provides the president with authority to impose tariffs to counter unfair trade practices, such as intellectual property theft or market manipulation by foreign governments. Through these legal avenues, the president can initiate tariffs quickly, often in response to a trade dispute or national security concern.
The enforcement of tariffs is primarily managed by U.S. Customs and Border Protection (CBP), an agency under the Department of Homeland Security. CBP is responsible for collecting tariff revenues, ensuring compliance with trade regulations, and monitoring imports to verify correct classification and valuation. Enforcement activities involve inspecting shipments at ports of entry, using advanced tracking systems to verify declarations, and imposing fines or penalties for noncompliance. In addition, the CBP works closely with other agencies like the Department of Commerce and the Office of the U.S. Trade Representative to ensure that tariffs support broader trade policies and protect domestic industries effectively. Tariffs are actively enforced through inspections and compliance audits, aiming to ensure that imported goods meet U.S. standards and that accurate duties are paid.
The solution for companies aiming to minimize their cost of goods sold
If the U.S. government significantly increases tariffs on imported goods, companies that sell products in the United States will face higher costs, as tariffs add to the cost of importing raw materials, components, or finished goods. To maintain competitive pricing and prevent these costs from eroding profit margins, companies will likely respond by exploring alternative strategies for sourcing, manufacturing, or assembling their products.
One common approach is to seek out lower-cost production locations that are exempt from U.S. tariffs. In recent years, companies have moved portions of their supply chains out of China, due to rising tariffs and tensions, and shifted production to countries like Vietnam, Mexico, and India, where labor and production costs are relatively low, and tariff rates are more favorable. For example, manufacturing in Mexico can be advantageous under the United States-Mexico-Canada Agreement (USMCA), which allows for tariff-free trade on goods meeting specific content requirements within North America. Moving production to countries with favorable trade agreements with the U.S. helps companies avoid the added cost of tariffs while retaining a competitive advantage in pricing.
For industries that rely heavily on complex components or raw materials, companies may decide to establish assembly plants or manufacturing operations within the United States, thereby reducing the need to import finished products subject to high tariffs. This strategy, known as “reshoring,” can offset the tariff impact by avoiding import duties altogether. Although labor costs in the U.S. are typically higher than in developing countries, some companies find that investing in automation and advanced manufacturing techniques can help offset these costs, making domestic production viable. This trend has become particularly evident in industries like automotive manufacturing, electronics, and high-value consumer goods, where technological advancements have made automation an increasingly cost-effective alternative to offshore labor.
In other cases, companies may choose a “nearshoring” strategy, setting up manufacturing and assembly plants in countries geographically close to the U.S. but with lower labor and operational costs than those within the U.S. itself. For instance, some businesses have established operations in Mexico or Canada to leverage regional trade agreements and reduce logistical costs. This approach not only provides cost savings but also improves supply chain resilience, allowing companies to respond more quickly to shifts in consumer demand and minimizing disruptions. Nearshoring can also appeal to U.S. consumers who value products made in neighboring countries or within North America.
Some businesses may take a hybrid approach, diversifying their production by maintaining some facilities in the U.S. while also producing abroad in low-cost countries. This diversification helps them hedge against potential trade policy changes, currency fluctuations, and supply chain disruptions. By balancing production across multiple locations, companies can better manage risks associated with tariffs and economic shifts. Additionally, in sectors with specialized production needs or those requiring close proximity to innovation centers, firms may retain high-value manufacturing domestically and outsource lower-value components internationally. This split approach allows companies to maximize both cost efficiency and product quality, all while staying adaptable to changing trade dynamics.
Another response to high tariffs is to engage in tariff engineering, a practice where companies modify their product designs or manufacturing processes to fall under different tariff classifications with lower rates. By altering the composition, assembly, or even the source of specific components, companies can sometimes reclassify products under codes with favorable tariffs, thereby reducing their import costs. For instance, a company might assemble certain portions of a product in a low-cost country and complete the assembly process in the U.S., creating a product that meets criteria for lower tariff classifications.
The “so what”
In an environment where the U.S. government imposes higher tariffs on imported goods, companies are compelled to adapt by exploring alternative production, sourcing, and manufacturing strategies to maintain competitive pricing and protect profit margins. Tariffs, though enacted as a tool for economic protection and revenue generation, inevitably impact business operations, especially for companies relying on imported goods. By relocating production to countries with favorable trade agreements, investing in domestic manufacturing through reshoring or nearshoring, and employing innovative cost-control strategies like tariff engineering, businesses can mitigate the effects of tariffs and maintain their foothold in the U.S. market. As global trade policies continue to evolve, companies that proactively adjust their operations to account for tariffs will be better positioned to thrive in an increasingly complex economic landscape.