Over the past few months, a number of folks in the media have compared tariffs to sales taxes. While tariffs are a form of taxation, they are fundamentally different from sales taxes.
Tariffs are imposed at the import stage based on the declared value of goods, which does not include subsequent costs like labor, marketing or retailer profit margins. Consequently, the effect of a tariff on the retail price is typically less than the tariff rate itself.
For example, a car might have a modest 5% markup, whereas luxury items can have markups up to 500%. Generally, consumer products are marked up over 100% above their import value, but only this import value, or “declared value” – not the final retail price – is subject to tariffs.
Consumers worry that retailers will simply pass on the cost of tariffs as increased wholesale costs. However, companies are more likely to seek cheaper suppliers, source from different countries or increase domestic production. After all, sourcing is not static or fixed.
Importers’ response to tariffs
How will importers respond to tariffs? They have a few choices.
- Absorbing tariffs: Importers might pay the tariff out of their profit margin to keep consumer prices stable.
- Sourcing from alternatives: They could shift production to countries with more favorable trade agreements with the U.S.
- Increasing prices: As a last resort, if neither absorbing the cost nor changing suppliers is feasible, the price to consumers might increase.
If importers find cheaper alternatives, they’ll adjust their sourcing to maintain profitability. Otherwise, they must decide whether to absorb the cost or pass it on to consumers, based on market tolerance for price increases.
Tariff impact and response
Importers are not the only party affected by tariffs. After all, for a large percentage of imports, there are two parties involved: the domestic importer and the foreign supplier.
President-elect Donald Trump has made it clear that he intends to direct a good portion of his tariff escalation on products sourced from China.
Chinese manufacturers will likely respond to tariffs by lowering prices to maintain competitiveness, avoiding loss of orders from U.S. importers. Additionally, the Chinese government might offer incentives and subsidies to its exporters, as it is known for supporting strategic industries and manipulating currency to counteract foreign trade policies.
Two decades ago, U.S. companies shifted production to China, leading to significant economic changes, including a decline in long-haul trucking dependent on domestic manufacturing. The entry of China into the World Trade Organization was particularly harmful to long-haul truckload carriers, as goods increasingly moved via global container ships and intermodal rail, bypassing traditional trucking routes.
However, bringing manufacturing back to the Americas could boost trucking demand, as manufacturing increases freight needs between suppliers, multiplying trips and miles in the manufacturing process. Consider the numerous movements of raw materials or components in the supply chain leading to the factory.
This scenario is akin to how attracting an auto plant increases employment when considering all associated suppliers in car manufacturing.
Not all manufacturing will return to the US
The primary goal of U.S. trade policy is to foster advanced manufacturing in sectors like electronics, machinery, pharmaceuticals, medical devices, aerospace, defense, agriculture, and oil and gas. Broad tariffs on Chinese exports encourage shifting supply chains out of China to other global regions.
Mexico should be a big beneficiary
During Trump’s first term, the United States-Mexico-Canada Agreement (USMCA) (or NAFTA 2.0) was established, making trade with Mexico more attractive than with China, nudging production back to the Americas. Trump has hinted at modifying this agreement to further favor U.S. companies, potentially targeting Chinese firms using Mexico for “border skipping.” This policy would likely be supported by Mexican policymakers for mutual benefits.
Sourcing from Mexico offers U.S. companies lower labor costs, reduced geopolitical risk and proximity to U.S. markets, accelerating the shift from China. Even with possible tariffs on Mexican imports, trade is expected to increase as companies prioritize supply chain resilience, benefiting U.S. trucking and rail.
Tariffs are not just for revenue or trade balancing but also for diversifying supply chains away from volatile regions, which is crucial for national security, especially with China’s potential threats.
The 2018 tariffs as a precedent
When Trump enacted 25% tariffs on Chinese goods in 2018, predictions of significant consumer price increases were largely unfounded. Price rises were minimal and temporary, with most effects absorbed within a year. The U.S. dollar’s appreciation nearly matched the tariff rates, mitigating inflation due to the dollar’s reserve currency status.
Tariffs are not purely a Republican policy; President Joe Biden has maintained and expanded some of Trump’s tariffs to include steel, aluminum, semiconductors, electric vehicles, batteries and critical minerals from China.
Moreover, the anticipation of tariffs often leads to an immediate surge in import activity, which benefits sectors like U.S. trucking, as seen in 2018 and currently in the freight market.
Other aspects of Trump’s policies, such as income and corporate tax reductions, bonus depreciation incentives, expansion of opportunity zones, and deregulation, are also expected to drive economic growth and goods consumption, increasing the conditions that will drive the freight market further out of the Great Freight Recession.