The Looming Border Adjustment Tax
From the campaign trail to President Trump’s first address to a joint meeting of Congress to ongoing commentary from major retail executives, there is no question that the current administration is in favor of tax reform.
Many key interest groups including investors, foreign trade partners, the congressional leadership, and global employers are currently debating the pros and cons of a border adjustment tax (BAT). Will the plan, which promotes US exports and discourages foreign imports, help the US economy?
Executives from global fashion brands including The Gap, JC Penney, and Target have already advocated against the border adjustment tax, noting that it unfairly penalizes importers and will increase prices for consumers. Other companies such as Boeing and Pfizer have voiced favorable opinions about the BAT, reasoning that it will support job creation by preventing US companies from moving abroad. So, what are the potential ripple effects of a BAT and, more importantly, how will it affect fashion retailers and consumers across the globe?
According to the American Apparel & Footwear Association more than 97 percent of apparel and 98 percent of shoes sold in the US are made overseas. Historically, it has been less expensive for retailers to manufacture and transport their goods from foreign countries where the costs of raw materials and labor are cheaper. If a BAT passes, retailers will be forced to adjust to the new regulations, meaning there will be incentives for retailers to move manufacturing onshore or near shore in order to avoid a 20 to 35 percent tax on imported goods.
Ideally, this is the goal of a BAT: to increase the number of exports from the US while decreasing imports, driving both job growth and economic development domestically. Now, what’s the catch? The value of the US dollar has to increase, and if it doesn’t, US consumers can expect to pay a lot more for everyday items. the National Retail Federation indicates the average US family could realize $1,700 in additional consumer good expenses in the first year alone if a BAT is enacted.
A BAT will likely only help middle- to high-level US fashion brands if they decide to operate production facilities on or closer to US soil, assuming they maintain and grow profits annually. The benefits of onshore manufacturing for fashion apparel include quicker speed to market and more direct collaboration among teams that are actually designing and manufacturing the garments. Instead of an average six to eight month cycle of designing, manufacturing, transporting, and importing products at locations spread across the globe, onshore production facilities have the potential to increase speed to market to a timeframe of six to eight weeks.
In the fashion industry, where timing is of the essence and the “it” trends are always changing, rapid design prototyping is becoming more important than ever. Minimizing the distance between the office where design occurs and the manufacturing site that produces garments or shoes en masse can help companies push product to market much faster. This is especially helpful for companies such as Nike who may decide to design a limited edition shoe, launch a guerilla marketing campaign, and create rapid demand through scarcity and social media promotion. There are several companies that have manufactured in the US for a long time and already know the benefits of onshore production, including Brooks Brothers, 7 For All Mankind, and AG Jeans, to name a few. However, it is important to note that, even under a BAT, lower-cost, commodity apparel products such as basic t-shirts or socks will likely continue to benefit from overseas manufacturing and the lower cost of labor and raw materials in foreign markets.
Even with the current uncertainty of the fate of a BAT, some companies are pushing to drive more US-based manufacturing. Under Armour is producing limited quantities of more fashion-centric apparel lines in Baltimore and Shinola leather goods prides itself on its manufacturing facilities and close connection to Detroit. There is always the potential that some states might potentially offer more incentives to jumpstart pilot programs or full manufacturing operations, which will create jobs and ideally, drive sales. However, training a skilled US workforce that is able to satisfy an influx for domestically manufactured and more technically complex goods will take years.
If a company decides that manufacturing within US borders is still cost prohibitive, then near-shore production in Mexico or Central or South America is an alternative. BAT import penalties will still apply but the cost of freight and transportation is likely less expensive than goods made in Asia or Europe. It’s all about weighing strategies that allow a company to spread increased costs across the entire supply and manufacturing chain and minimize any increased expenses to the end consumer.
To stay afloat during this tumultuous time, retailers need to maintain business resiliency and stay competitive in a changing marketplace. For example, if a company has a 20-percent tax increase on their imports, executives need to anticipate and discuss who will incur those additional costs. Will it be the customer, the company, the vendors, or will it be spilt among various stakeholder groups? Further, companies will look for loopholes, just as many do today, to reduce the impact of an import tax. Examples of those strategies may include slight alterations to product materials that will shift the goods into a different import classification or shipping a good that is 95 percent finished into the US and using a domestic facility for manufacturing completion.
A border adjustment tax could potentially shake up relations between the United States and close trade partners. Companies that move their production facilities from foreign companies to the US will lay off local workers in markets abroad to make room for American workers. This is a win for American workers, but will impact our overall international relations with certain countries. Also, if the value of the US dollar does rise as a result of a BAT, products made in the US might become too expensive for foreign buyers, decreasing global demand for US exports. In today’s complex and globalized market, where consumers can purchase goods across multiple platforms anytime and anywhere, the value of the US dollar will have a drastic impact on both American and foreign consumers’ spending power.
Retailers worldwide will need to brace for impact if a US border adjustment tax passes, but there is no need for hasty action. If companies choose to react too quickly to legislation, it will take many years to make true sea changes in their business. Retailers and related manufacturing operations should focus on mitigating the impact of any new regulations on all areas of the supply chain, with a primary goal being to minimize cost increases for end consumers. At the end of the day, these businesses exist to serve their customers, and need to put the interest of the “almighty customers” at the forefront.
Andrew Billings is a principal and senior leader in North Highland Consulting’s retail and CPG practice.
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