The Tariff Mismatch
Purchasers' Unseen Penalty Hits Hardest on Low-End Items

By Paul Blustein
Washington Post Staff Writer
Sunday, December 11, 2005

By all appearances, Sterlicia Rodney does not belong in a high tax bracket.

Juggling her toddler son in one arm while standing in line at a Payless ShoeSource in downtown Washington to buy $18 boots for her daughter, Rodney looks every bit the regular working mom that she is, with a $45,000-a-year job as the assistant to the vice president of a trade association.

But as a frequent purchaser of low-end footwear, Rodney pays hidden taxes that are among the steepest imposed on any product sold in the United States. Nearly all of the shoes sold in this country are made abroad, and the companies importing them must pay tariffs to the federal government that, to some extent at least, are passed through to the retail price. Tariffs are particularly high on athletic shoes; at discount stores, where sneakers typically cost $10 to $25 a pair, tariffs account for about $1.50 to $3 of the price -- or even a couple of dollars more, by some estimates.

"You wouldn't think it would be taxed so high because it's something you need to buy all the time," Rodney said. "Young kids grow out of them so fast."

Surprising as it may be to Americans who think of their country as a bastion of free trade, shoes are just one of many products subject to high tariffs. Although the average tariff on non-agricultural goods imported into the United States is less than 3 percent, tariffs on a number of everyday consumer products -- including clothing, luggage, dinnerware and handbags -- range well into double digits. The same goes for some food, such as butter and cheese. (These tariffs are separate from special duties imposed on certain foreign products that the government has found to be "dumped," or sold at unfairly low prices.)

The issue is coming to the fore as top officials from the World Trade Organization's 149 member countries gather this week in Hong Kong in hopes of advancing long-running negotiations to lower the barriers to commerce across international borders.

The governments involved in the talks face tough decisions. Although reducing obstacles to trade can help economies grow more rapidly and efficiently in the long run, exposing domestic industries to global competition can lead to factory shutdowns and job losses. Another thorny issue concerns how to make the international rules on trade in farm goods more beneficial to poor countries.

But for most Americans, the stakes are less cosmic. The talks' most tangible implications for the bulk of Americans -- heavy consumers of foreign goods -- concern the potential savings from a reduction in tariffs on commonly purchased products. That is particularly true for people at the middle and low segments of the income scale because the system has evolved in a way that produces a bizarre result: Some of the stiffest tariffs apply to the types of goods that people of modest means tend to buy, and lower duties are imposed on similar products that are more often purchased by upper-income individuals.

Sweaters offer a vivid example: If they're acrylic, the tariff is 32 percent. But if they're wool, the tariff is 17 percent. On cashmere sweaters, the tariff is lower still -- 4 percent -- and on silk ones, 0.9 percent. (Tariffs are levied on the "ad valorem" value of a product when it enters the United States -- the amount the importer pays, excluding insurance and freight. So for an acrylic sweater with an ad valorem value at the border of, say, $10, the 32 percent tariff would be $3.20.)

In the case of low-end sneakers, tariffs range between 48 and 67 percent, but tariffs on higher-end sneakers are only 20 percent, and for leather dress shoes, the tariff is 8.5 percent. Plastic handbags are hit with 16 percent tariffs but reptile-skin ones with only 5.3 percent tariffs. For drinking glasses, the tariff is 28.5 percent if the value at the border is 30 cents or less, but 5 percent if the value is $5 or more.

"Over the past 40 years, we've created a very skewed system, where many of the things that poor families buy are very heavily taxed, and things that only rich families buy are not," said Edward Gresser, a trade expert at the Progressive Policy Institute, a Washington think tank. "Of the five different kinds of taxes that the federal government imposes, tariffs are the smallest -- but they're by far the most regressive."

A former official at the U.S. Trade Representative's office during the Clinton administration, Gresser said he was taken aback by the perversities in the tariff system when he started scrutinizing it a couple of years ago. The task required poring over the official tariff schedule, a document filled with eye-glazing product categories. (One typical example: "Textile fabrics coated with gum or amylaceous substances, of a kind used for the outer covers of books or the like: tracing cloth; prepared painting canvas; buckram and similar stiffened textile fabrics of a kind used for hat foundations.")

"This system is costing people quite a lot of money, and the more I looked into it, the more shocked I became," Gresser said. "How did we let this happen?"

The answer in some cases -- though by no means all -- is that Congress has never gotten around to lowering certain tariffs that were once designed to protect major U.S. industries even though the industry in question has undergone major changes or almost disappeared.

Sneaker tariffs are a classic example. According to the American Apparel and Footwear Association, the tariffs have their origins in the 1920s, when U.S. tire companies -- which then made rubber footwear -- wanted to fend off an onslaught of cheap shoes from Czechoslovakia. In later decades, U.S. athletic-shoe makers lobbied successfully to maintain protection against imports from places such as Taiwan, so tariffs remained high on sneakers even as they fell on leather shoes. The tariffs, however, haven't kept shoe firms from moving most of their production to developing nations with low-cost, high-productivity labor pools -- China in particular.

These days, New Balance Athletic Shoe Inc. is practically the only sneaker company that continues to manufacture in the United States (specifically, in Massachusetts and Maine, where about 25 percent of the shoes it sells are made). Although New Balance strongly favors keeping tariffs on some types of shoes it makes domestically, it agrees with most of the rest of the industry that other shoe tariffs ought to be eliminated. But no global trade deal has come along in the past few years to afford an opportunity to do so. And although the North American Free Trade Agreement eliminated duties on Mexican products, shoemakers have generally resisted moving operations to Mexico, partly because of onerous NAFTA "rules of origin" requiring them to show that shoes shipped to the United States don't contain other countries' materials or manufacturing input.

The current WTO negotiations will presumably offer the next chance to comprehensively modify U.S. tariffs. So far, however, other issues in the talks have overshadowed the impact on U.S. consumers.

Known as the "Doha round" because they were launched at a meeting in the capital of Qatar in 2001, the talks are aimed at spurring greater global trade in general, with a particular focus on giving developing countries a bigger share of the gains. Because poor nations depend heavily on agriculture, much of the debate has revolved around proposals to cut the tariff protection and government payments that farmers get in the United States, the European Union and other rich countries. Farmers in poor lands face serious obstacles in selling their goods abroad, and they sometimes suffer from worldwide crop gluts that arise because subsidy payments in rich countries lead to overproduction.

This week's meeting in Hong Kong was originally supposed to speed the talks toward a final agreement by producing a blueprint that would include details such as the type of formulas to be used in cutting tariffs. But negotiators have already acknowledged that they are unlikely to agree on much more than a schedule for striking a deal by the end of 2006. Because the WTO operates by consensus, all 149 member nations must sign on to an accord, which means all must believe they have more to gain than lose, both politically and economically -- and they are far from reaching that point.

Most importantly, the European Union -- fearful of arousing the wrath of farmers in France and other E.U. countries -- has refused to offer the prospect of deep cuts in its agricultural tariffs. In response to accusations from Brazilians and others that European intransigence could scuttle the talks, E.U. officials retort that Brazil hasn't even submitted a proposal to trim tariffs on its heavily protected industries.

U.S. consumers' interests haven't gone completely without notice. In a bid to grab the high ground in the talks, the Bush administration proposed in 2002 to eliminate all U.S. tariffs on manufactured goods by 2015, provided other WTO members would respond in kind. A "tariff-free world" would create major opportunities for U.S. exporters, and scrapping U.S. tariffs would save Americans $18 billion a year, the administration said.

To drive home the point, the trade representative at the time, Robert B. Zoellick, held a press conference where he displayed a basket of goods, including flashlights, pacifiers, disposable cameras, men's sweaters and children's clothing. Without tariffs, those items, which cost $202 at Wal-Mart, would cost $170 -- "a heck of a price rollback," as Zoellick put it.

But the proposal was widely derided as pie-in-the-sky. In part, that was because it was certain to be rejected by other countries, which tend to have much higher tariffs than the United States' and would thus have to make much deeper cuts. Moreover, powerful forces within the United States would never stand for a zeroing-out of tariffs, and their clout in Congress -- which must approve any WTO pact -- is formidable.

Among these is the textile industry, which contends that its survival depends on reasonably high tariffs, especially now that global trade rules no longer impose ceilings on the amounts of textiles and apparel that individual countries can export.

Regardless of the apparent benefit to consumers of tariff cuts, "consumers have to have jobs [in order] to consume," said Augustine D. Tantillo, executive director of the American Manufacturing Trade Action Coalition, a group representing many textile firms based in the Southeast.

To that argument, the administration and its free-trade allies respond that an abundance of job creation will flow from the wealth and productivity generated by lower prices and additional international commerce. But industries that rely on tariffs also argue that they need to be sheltered against imports as a matter of fairness because some foreign countries subsidize their exporters. The dairy industry, for example, asserts that subsidized butter and cheese from Europe and elsewhere would wipe out U.S. dairy farmers without lofty tariffs on those products.

Finally, there is the question of whether tariff cuts would really translate into lower prices at the retail level. "It's a rather lofty assumption that the retail community would pass on these benefits fully to the consumer," Tantillo said.

No one can prove how much tariffs affect retail prices. According to one school of thought, tariffs are systematically passed on through each stage of the wholesale and retail process. A $3.20 tariff on a $10 acrylic sweater, for example, increases the cost to $13.20 for the importer, who marks up that price by some percentage -- say, 50 percent -- before delivering the sweater to a retailer, who marks it up again by some percentage of the wholesale cost. Thus the consumer ends up paying not only the $3.20 tariff but also markups on the tariff.

Many people familiar with the importing business say that's how the system often works. "I don't think there's any doubt that if tariffs are reduced, retail prices will go down even further," said Robert L. Steiner, a former business executive and Federal Trade Commission staffer who has published a number of scholarly articles on retailers' behavior. "And if tariffs go up, retail prices will rise even more."

Steiner has marshaled evidence to bolster the case. Using government data, he found that gross profit margins earned by retailers have stayed remarkably constant over a number of years, which suggests that they systematically mark up their merchandise based on their costs including tariffs.

Advancing an opposing view, Robert E. Scott, an economist at the liberal Economic Policy Institute, said his research suggests that retailers wouldn't reduce prices much if tariffs fell because big retail chains have increased their market power enough to charge higher margins.

The truth probably lies in between, according to economists who cite studies showing what happens to retail prices when changes in foreign currency rates affect the cost of imported goods. "About half of the benefit of lower prices gets passed through, and about half somehow disappears in markup adjustments," said Thomas W. Hertel, a professor at Purdue University who has studied the potential impact of a WTO accord.

Whatever the truth about markups and pass-throughs, the basic unfairness of the tariff system bothers LaCresia Jack, another Payless ShoeSource customer, when she is told that tariffs probably inflated the cost of shoes she is buying by some amount.

"Being a paralegal, I'm trying to get my mind wrapped around this," said Jack, who works for an Energy Department contractor. "Why wouldn't the things that cost the most be taxed higher, since the people buying them can afford them? This is a little backwards."

"The shop owners say, 'We're getting gouged -- we have to make our money,' " she continued. "Now I understand. They're getting gouged, and so are we."