In the suburbs of Chicago, a company called Learning Resources maintains 350,000 square feet of warehouse space, with 25,000 pallets stacked high with toys. The toy microscopes, doctor’s kits, kitchen sets and other educational goods eventually make their way to stores such as Toys R Us and Target.
They’re designed in Vernon Hills, Ill., in the same office complex, but the company relies on Chinese factories to make them: To mold plastic pellets into shapes, to paint on designs, to install the tiny LCD displays in kiddie cash registers.
And because of this dependence on a global supply chain, recent events in Washington have sent chief executive Rick Woldenberg into something of a panic.
President Trump has talked often of overhauling America’s tax code with an eye toward encouraging U.S. companies to make things stateside. And under a tax reform plan being touted by Republican congressional leaders, Woldenberg estimates that his company’s tax bill would jump to an eye-popping 165 percent of its earnings. He expects that would push him to raise his prices 10 to 15 percent, and given those higher prices, he believes his sales volume will plummet around 40 percent.
“I sort of feel cornered here,” Woldenberg said. “I’m resentful because I haven’t done anything wrong.”
Learning Resources is a relatively small company, but its existential fears reflect a mindset shared up and down the retailing and consumer goods industries. For importers of toys, apparel, electronics, all eyes are on the future of a proposal known as border adjustment tax, in which companies would no longer be able to deduct the cost of overseas goods. And Woldenberg’s arguments might offer a preview of what’s to come as big-name importers ramp up their exhortations to Washington to abandon this approach to tax policy.
Many economists say that retailers’ and others importers’ fears about such a tax are unfounded, because their analyses find that currencies will adjust in a way that offsets that change.
But trade groups representing major retail and apparel companies say their members are not convinced, and are deeply concerned that these taxes will force them to significantly raise prices for consumers. That’s because they believe such a measure would dramatically eat into their already narrow profits — or wipe them out altogether.
Now, with a Republican president aligned with Congress’s agenda, some see a greater likelihood that this so-called tax blueprint, or some close cousin of it, could become law.
Meanwhile, many of those same companies are contemplating other threats to their business model, including the possibility that they could be dealt a serious blow if Trump moves forward with his campaign rhetoric about slapping hefty tariffs on goods coming in from countries such as China and Mexico, adding up to a moment of serious uncertainty.
Theory and practice
Economists are befuddled that the idea of a border adjustment tax is creating such anxiety among importers. Here’s how it would work under the plan floated by House Republicans: Companies would be able to deduct the cost of exported goods from their tax bills, but not the cost of imports. Effectively, it amounts to a tax on imports.
But economists say that under that taxation scenario, the value of the dollar would soar, thereby significantly cutting these businesses’ cost of goods. Therefore, the theory goes, they would not actually see a skyrocketing tax bill, and they wouldn’t therefore be forced to ratchet up prices for consumers.
“I think the focus on just the import costs and export prices, ignoring the potential exchange rate effect, is mistaken,” said Alan Auerbach, director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley. “It’s understandable. But this is something that’s affecting the whole economy, not just one industry.”
Woldenberg, for one, is skeptical as to whether that will play out in the real world like it does in the textbooks. Like many of his U.S. counterparts, his contracts with overseas factories are all in dollars. So he struggles to see how global currency fluctuations would affect his cost of goods.
Auerbach concedes there might be some short-term pain there: Woldenberg and others like him would be stuck with the terms of their existing arrangements. But, for contracts on a go-forward basis, they can base their price negotiations on the new reality.
Woldenberg worries it won’t be so simple to re-negotiate such contracts, particularly if the dollar doesn’t rise as much as economists expect and he has to try to cut costs. After all, he’s already trying to get the best prices out of his suppliers. And then there’s the fact that a move like this could ripple deeper into the supply chain. If Learning Resources tries to squeeze better prices out of a manufacturer, what would that mean for the companies that sell pellets and other materials to that factory?
“There’s just not any fat there that’s obvious,” Woldenberg said.
Plus, Woldenberg worries about how things could go if he tries to muscle his way into prices that are so low that they are unsustainable for his suppliers.
“I am dependent on these factories. If these factories destabilize and fall apart, some of them can literally knock my company for a loop because they have a high concentration of my business,” Woldenberg said. “I am very, very wary of doing something that will cause them to be unprofitable. If they sneeze, I can catch cold.”
It’s not that Woldenberg hasn’t thought about making toys in the United States. He put out some exploratory phone calls to domestic molders back in 2013, and reached out to one again in 2016, to see whether they could take over for Chinese factories.
“I’m sure we can beat their prices,” Woldenberg remembers them saying. “Send them to me, I’ll give you a quote.”
He then shared information about a small number of toys in his catalog of 1,400 products, some of the ones that were easiest to make. It didn’t go anywhere.
“Our product is a labor intensive, low-tech item,” Woldenberg said. “That’s not what U.S. manufacturers specialize in. U.S. employees want to be paid more. They want to make $35 an hour and screw together cars.”
Woldenberg is part of a chorus of voices urging lawmakers to walk away from the idea of a border adjustment tax. The National Retail Federation, for example, has been criticizing this tenet of the plan, saying it would simply result in consumers seeing higher prices on store shelves.
“Economic theorists are playing with fire and it’s the consumer who ultimately will lose,” said David French, NRF’s senior vice president for government relations, in a news release issued this month.
Other groups, too, have expressed similar concerns, including Americans for Prosperity, an advocacy group backed by the Koch brothers.
“Border adjustability is nothing more than a tax on American consumers,” Tim Phillips, the group’s president, said in a statement. “We are against this approach because in the end, it is making life more expensive for all Americans, especially low and fixed-income families.”
But they may face a tough audience on Capitol Hill. Rep. Kevin Brady (R-Tex.), chairman of the House Ways and Means Committee, is talking up the the border adjustment plan as a framework for helping U.S. exporters. According to a transcript of prepared remarks he made to the U.S. Chamber of Commerce this month, Brady said, “This tax disadvantage on ‘Made in America’ products and services destroys true competition. Worse, it often means the best location for a U.S. company to sell to America is overseas. Why accept such an unfair and job-killing tax code?”
Woldenberg recently met with members of Congress to press his case, and he says he’ll continue to sound the alarm about what he predicts will be the effects to his business.
“I have a business that’s healthy and growing and serving the needs of families,” Woldenberg said. “And it will be just thrown into some sort of tremor by this, some sort of corporate epileptic fit.”