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Tax Reform, Import Tariffs Threaten the Fabric of the Apparel Industry

We may still be on the eve of Donald Trump’s inauguration as the 45th president of the United States, but the Trump effect has already been reverberating through the apparel industry.

Since Nov. 8, questions have swirled about how the President-elect’s campaign promises could impact our industry. Chief among them were his plans to levy hefty tariffs against our No. 1 trade partner. Then-candidate Trump had mentioned a 45 percent tariff on goods from China. More recently, there have been reports his team is eyeing a blanket 10 percent tariff on all imports.

Meanwhile House Republicans have been developing their own plan to make America great again. In the “A Better Way” tax plan introduced in June, GOP members outline a border adjustment tax designed to level what they see as an unfair playing field for U.S. exporters abroad.

Trade walls

Judging by Trump’s actions with regard to the Carrier air conditioning company and Ford automakers, what he said in his recent press conference and what can be gleaned from his Twitter feed, his plans seem focused on discouraging companies from investing overseas and moving jobs there. It’s a message that resonated with many of his supporters.

But is potentially singling out a particular country—especially China—a good idea?

“We are married to China,” said chief merchandising officer at Untuckit men’s wear, Bjorn Bengtsson. “We might dislike certain things, but they own a lot of our government debt, and we need them. The only ones who will suffer are the consumers because prices will go higher.”

If we do wake up to a burdensome tax on Chinese-made goods on Jan. 21, Bengtsson predicted companies will begin to shift production elsewhere—the question is when.

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The apparel production cycle is notoriously long lead, not to mention the time it takes to get new factories up to speed. In the face of these challenges, brands are already running scenarios, as they try to read the tea leaves in each new incendiary tweet.

“Just the conversation can be very disruptive because a lot of people are panicking now, and as importers, we don’t know where to go and a lot of people are affected,” said Howard Kahn, executive chairman of Kahn Lucas, a 128-year-old girls’ apparel company, voicing the concerns of so many in this industry. “People have manufacturing planned out for years. What’s the potential hit for companies that have significant commitments in China?”

Kahn said ultimately the American consumer will have to reach deeper into his and her pocket. “If there’s a 45 percent tax, who do they think is going to pay for that?” he said. “Initially it’ll be the importers but beyond that, it will be the consumer.”

And for those brands looking to get out of China, Bengtsson said they should prepare for sticker shock as well. “Those places will raise the prices when they have 55 people knocking on their door instead of the usual three or four. When demand outstrips supply, prices go up. The net effect is negative for apparel no matter how you turn it around.”

Tax overhaul 

In terms of the border adjustment tax, it would lower corporate income taxes from 35 percent to 20 percent, which is a positive thing. However, those same companies would no longer be able to deduct the cost of goods for products that were imported.

Exporters, on the other hand, would still be able to deduct the cost of goods.

In other words, take a jacket that was made overseas for $65 with an additional $35 in marketing, fulfillment and transport expenses once it arrives here. If the jacket is sold in the U.S. for $175, the brand would typically pay taxes on the $75 profit. Under the new tax system, the company would be taxed on the profit plus the cost of imported goods, or $140. Therefore, taxes would increase from $26.25 to $28.* Now multiply that by millions of products.

Supporters in the Republican party hope this would give U.S. exporters the same advantage that foreign companies that operate on a value-added tax (VAT) system enjoy. In those cases, brands that export goods are rebated the VAT. Further, they say it would strengthen the dollar, thereby reducing the cost of imports, offsetting the impact on corporations.

The tax plan also includes incentives for moving capital back to the U.S.

“Since election night, people have been asking how [border adjustability] will impact the industry, but they’re not asking the right question,” said Tom Travis, managing partner of the Sandler, Travis & Rosenberg customs and trade law firm. “The question is, ‘How will it impact me?’”

For every company, how they do business, where they produce, how they operate and where they sell is different, so the possible effect would be different, he said.

“No shoe fits all sizes,” Travis said. “The companies that are planning their supply chain activities have to carefully evaluate how that proposal eliminating the deductibility of those costs affects them against the benefits that are provided by lower corporate taxes and some of the repatriation of capital provisions.”

Comparing the two ideas—tariffs on imports versus a sweeping overhaul of the tax system—Steve Lamar, executive vice president of the American Apparel and Footwear Association, said that for the most part, Trump’s proposals have been more targeted to specific areas, which would affect specific companies. On the other hand, the tax overhaul would touch every business along the supply chain.

Many consumer products industries have come out against the tax overhaul. And they’re not the only dissenters. The President-elect is not a fan either. In an interview with the Wall Street Journal Friday, he said he opposes the Republican border adjustment plan, calling it “too complicated.” Trump has indicated he’d be in favor of a simple corporate tax cut as a way to incentivize companies to stay in the U.S.

Part of the issue for our industry is that not enough is known about the details of the border adjustment tax yet. Ron Sorini, principle of trade consultancy Sorini, Samet & Associates, anticipates there may be exemptions for certain types of product, especially those with U.S. components.

“My guess is those kinds of changes will be made because otherwise you’re creating an obstacle to exports if you treat an import apparel the same whether it uses U.S. or foreign cotton or yarn,” he said. “Then, there’s a disincentive to use U.S. yarn, which is not what they want to accomplish.”

If that’s the case, Sorini said the U.S. textile market could benefit the most followed by U.S. apparel companies operating in places like Mexico, Haiti and Central America using U.S. inputs.

While everyone crunches the numbers to see how the proposed measures could affect them, Lamar has a few figures he’d like lawmakers to consider before they make any decisions that could hurt U.S.-based businesses.

“We like to say there are three numbers you need to know to understand how our industry works: 98, 97 and 95,” said Lamar. Ninety-eight percent of the shoes the U.S. consumes are made offshore. For clothes, it’s 97 percent. And 95 percent of the consumers for these products live outside of the U.S. “If you understand those numbers than you know we need access to global suppliers and consumers.”

Stay tuned for Part II of this coverage, looking at whether Trump will be able to stimulate U.S. apparel manufacturing. It will run in SJ Thursday morning.

*The story has been edited to correct the tax calculation example.