25%. Wait, what?!

This is the second in a short series of articles about being a co-founder of a startup caught in the crossfire of global trade wars. I'm aiming to shed some light on the realities of trade policy from the perspective of a small business owner (and consumer and citizen) based in the US. We'll be taking some hefty detours into economic theory as well as how I see the political reality. I strive to be balanced and reasonable; hopefully that's on-brand if you know me. All opinions are my own. But the facts are everyone's! Buckle up...

Last time, I mentioned that a tariff imposed by the US government is paid by businesses importing those goods into the US (typically US businesses). This seems to come as a surprise to many people who think that a tariff on goods coming from China is paid by China. The reality is that China (and Chinese exporters) don't pay a single penny directly. This is just a fact.

But that still left us with the obvious further question: beyond who makes the actual payment, what are the effects? That's what I'll start to get into today first by thinking about the effects rippling out from a single business, using the example of my own experience. Next time we'll get deeper into manufacturing decisions and then after that broader economic and political debates.

First, a little context. We started working on True Places a few years ago as the current US-China trade war was really in its infancy. Like other entrepreneurs, we had a dream, and an idea we couldn't shake that we knew needed to exist. In our case we wanted to build a company for what we call the modern outdoors - the hours every week that millions of people spend just outside their doors...in their backyards, on the sidelines of kids sports games, at concerts in the park, local festivals and hundreds of other situations. We noticed that people mostly use uncomfortable camping gear that wasn't designed for these occasions, and we were fed up with the situation ourselves. Our first product, custom designed and created from the ground up, is the Emmett Portable Chair, which of course I think is awesome.

Designing and engineering the Emmett (not to mention applying for patents and planning out every other aspect of the business) was a long road, mostly traversed at the height of the global pandemic, and we finally started shipping the first version of the product to our very earliest customers in late 2021.

By that time, the various tariffs imposed by the Trump administration (to be fair, the Biden administration has continued the trade policy; one of the few areas of bipartisan consensus in DC) were in effect, including the category that our product falls under which went from 0% to 25% duty.

What does that percentage mean? It's a percentage of the cost of the product (in accounting jargon: cost of goods sold "COGS"), so 25% means as a US business bringing products into the US from our factory in China, we pay the US government an extra 25% of the cost to produce i.e. our costs increased by 25%.

Twenty-five percent! I don't know if that sounds like a little or a lot to you, but I can assure you it's a lot. When you're putting together the business plan for a startup, everything is an assumption. You know that the assumptions will mostly be wrong. But even in this context, a swing of 25% in your costs is huge.

For brevity, I'm describing being hit with the tariff with a clarity that only exists when talking about the past, after things have already happened. But it's important to note that the way these trade policies get implemented is anything but clear. There were a few years worth of political posturing, threats, diplomacy, bilateral and multinational trade talks and phases of tariffs. There were exclusions, windows of so-called comment periods, extensions to exclusions, HTS (harmonized tariff schedule) code changes. The operational responsibility for all of this for the entire US economy falls to the Office of the US Trade Representative (USTR), a federal agency of about 200 employees.

If all this sounds bewildering, it is. In short, it was very unclear exactly what would happen with tariffs, what that would look like in practice, when anything would happen and whether it would be temporary or permanent. In the meantime, we were (are) trying to build and run a startup.

The point here is that even just trying to figure out what is going on, let alone figure out how to deal with it, takes a lot of time. That's one thing that people running small businesses don't usually have in abundance. We spent hundreds of hours trying to find out as much as we could. I vividly remember spending two full weeks non-stop going deep into USTR documents online, something I do not recommend or wish on anyone. I'm not looking for sympathy but to note that we are merely one tiny startup; multiply that by hundreds of thousands of businesses across the economy and it adds up to a lot of time. None of this is captured in any statistics (maybe ultimately in macro productivity data, but good luck trying to truly explain the sources of productivity growth or declines - economists have been arguing about that for decades). Call it friction, transaction costs or whatever you want, but I'm yet to see it considered seriously in any trade policy proposals or evaluations.

But back to the main question - what does an individual business do now that it faces an extra 25% tax?

Either you figure out a way to avoid the tariff, or you deal with 25% higher costs. I'll come back to avoidance shortly, but let's assume you are paying the tariff. With higher costs, you then try to pass as much as possible on to your customers in the form of higher prices. The inevitable result is some contribution to inflation. In other words, it's American consumers who end up paying the so called China tariff. Economists will debate how much of the tariff flows through to consumers, but I am confident it's not zero.

The likely result for an individual business of charging higher prices is fewer customers and lower growth. The alternative is to reduce any profits or try to reduce other costs. If you are in a position to do either of those as a startup or small business, you are very lucky! I can say for sure that in our case, our higher costs have constricted our growth, reducing investments we would have otherwise made in marketing, product development and hiring. I doubt we're alone.

What about avoiding the tariff? There are a few options here, ranging from clearly legal, to clearly illegal with some grey areas in between. I guess this is why trade lawyers are paid big bucks. Again, I'm not a lawyer but some of the examples I've heard through many discussions include the following.

At the clearly illegal end (i.e evasion rather than avoidance) is just not paying it or otherwise mis-representing what you are bringing in to the country (through various means from outright smuggling to illicit manipulation of HTS codes [these are the thousands of different customs codes classifying products]). My co-founder and I wouldn't consider any of these; we want to live in a society where all laws are respected even if we wish they weren't there ;) But obviously there will be some people who make different choices.

In the grey area is probably a wider range of ideas than I know about. These are the kinds of things where depending on the circumstances a clever lawyer could likely make a fair case that it's not against the law. Examples could be classifying the product under one HTS code rather than another when there is even a hint of ambiguity or mixture of materials or uses (the existence and level of tariffs varies wildy across HTS codes and it's impossible to perfectly describe every kind of product). Or moving the product first to a third country to finish it in some way and claim that third country as the country of origin. I saw a news article a while ago mentioning an analysis of aggregate trade flows indicating this happens a lot. These are the kinds of tactics often employed by large companies with resources to put against figuring this out.

One other area that is technically legal but I would argue in reality ends up being somewhat dubious is government lobbying. I'll save a deeper discussion for the future, but for now note that there are an insane number of detailed classifications of products (those HTS codes) and each could have a different tariff level, or none at all. How should each classification description get written? Which products should be under special exclusions where tariffs don't apply (this is a big one)? Should a tariff be 10%? 25%?

At the extreme you get corruption. I'm not sure exactly where the line between corruption and legitimate lobbying is or should be and I'm not accusing any particular people of corruption, but, as a society, it's worth considering these questions. Trying to influence detailed policy decisions is part of our system of democracy, so in that sense this is how it should work. However, the more the government interferes in the economy in this way, treating some differently with things like tariffs, the more special interests and lobbying you get. And obviously those with more resources and power (big businesses or powerful special interests) get more influence. In economics jargon this behaviour is slightly confusingly called "rent-seeking", which makes it sound like someone just looking for housing, but it's essentially trying to gain wealth or benefit that's got nothing to do with being productive. It's just fighting over the distribution of wealth/resources, so there's a lot of waste involved.

Here's one tiny example of how this plays out in reality (again imagine multiplying this by millions of times across industries and businesses). After spending enough time combing through the details of government tariff documentation, the effects of lobbying almost comically start jumping out. We had to figure out what classification our new product falls under (yes, this is the kind of unsexy work founders have to spend stupid amounts of time on) and the descriptions get incredibly detailed - there are a large number of different ones related to portable chairs and at least 4 or 5 that could describe what we had created.

As I was trawling through the list of classifications that were excluded from the tariffs (yes, there was a long list of product to which the tariff magically did not apply), I start noticing some oddly specific ones. For example:

"Stackable upholstered metal chairs for religious worship settings, capable of interlocking with each other, each with attached holders and racks (described in statistical reporting number 9401.71.0031)"

And:

"Hunting stands of steel or aluminum (including ladder stands, pod stands, hang-on stands and climbing stands), each of which allows one or more hunters to ascend to a height and sit while waiting for game animals to appear (described in statistical reporting number 9401.79.0035)"

Now, I've got nothing against the interlocking religious worship seating manufacturers, or high-chair game hunters, but it does beg the question of why there seems to be some very special treatment here.

This is what rent-seeking looks like.

Finally, in terms of the most clearly legal options for individual businesses to avoid tariffs, there are two main categories that come to mind. The first is to take advantage of any legal loopholes that exist. I'm sure the possibilities vary radically across industries and situations, but for us and other ecommerce businesses there is one big one: the "De Minimus Tax Exemption". This is a fancy name for a US law that goes back to the Tariff Act of 1930 - you can ship goods valued at under $800 into the US to an individual person free of any duty or taxes.

The original intent made a lot of sense; imagine you're on holiday in Mexico and you pick up a few souvenirs to send back to yourself. Neither you nor Customs and Border Protection (CBP) would want to bother figuring out tariffs or duties on such a small amount. So it reduces a lot of friction and expedites shipments.

However, it wasn't designed for modern ecommerce. To give you a sense of scale, the CBP reported that over 1 billion (!) shipments entered tax free under the de minimus rule in 2023, which was a whopping 53% increase from 2022. This is how companies like Temu and Shein are able to operate they way they do, especially with small packages, drop-shipping directly from factories in Asia. And note, as an aside, small packages are cheaper to air-freight, so again you get arbitrary winners and losers (if you happen to deal with physically small products, congratulations, you get to avoid the tariff). Once you start noticing unintended consequences, you see them everywhere!

Some kind of reform of the de minimus law is currently being hotly debated in Congress and as you can imagine as with any rule once it exists there are voices on all sides from those who currently benefit and those who are argue they are unfairly hurt. My point here isn't to debate it (maybe a topic for the future), but rather that once you start putting things like tariffs in place there are inevitably loopholes and other unintended consequences. You may still conclude it's worth it, but you have to be honest about all the effects.

In our case, we spent a lot of time trying to figure out how to use the de minimus rule and quickly ended up with some convoluted operational gymnastics. If we import our products to a warehouse in say Seattle, we pay 25% tariff on the whole lot. But de minimus means that if we import it to a warehouse just over the border in Vancouver Canada and ship to individual US consumers from there, we don't pay the tariff.

So we tried doing a version of this - we shipped containers to southern California, had it driven down into Mexico on a bonded truck so it legally didn't clear US customs and to a warehouse across the border from which we shipped to individual customers in the US and elsewhere. My co-founder and I even flew down and spent a week working at our warehouse in Mexico, which is a whole other story for another time.

We have subsequently stopped doing this whole arrangement - it added operational costs, shipping costs (e.g. across the country to the northeastern US) and we wanted to have our product stored much closer to us so we could inspect and deal with it ourselves more easily. We've given up trying to use the loophole and we now just pay the tariff to get our product to our US warehouses, which we really can't afford.

But that whole experience gave me a glimpse of all the crazy (unintended) effects of the trade policy. An entire industry of warehouse operations has sprung up on the Mexican side of the border serving US ecommerce brands. I'm guessing that US policymakers didn't intend to boost employment in Mexico, but it's been great for that local economy near the border!

OK, back to the business options...the last legal path to avoiding the tariff is of course to move manufacturing away from China. You've probably been wondering "why don't you and everyone else just do that? Isn't that the whole point of tariffs?" Well, we'll discuss that in the next article...

If you made it all the way here, please let me know! That will help me know that it's worth continuing this series.