Import duties as a tax and hidden subsidy
Friday, May 22nd, 2015
By Piet le Roux, Head: Solidarity Research Institute
While historically import duties were one of the major sources of income for governments and regents, they have been of lesser importance in modern times. Dwarfed against the extent of instruments like personal income tax and VAT, import duties are today often regarded as a form of trading policy rather than a tax. It is however important to remember that all import duties are also at the same time taxes and, moreover, that they represent a hidden subsidy.
Since import duties are such a complex issue that economists, statisticians, business people and civil servants seem unable to come to any lasting agreement about them, it may be useful to examine them from a wider perspective. This article proposes a simple test which may be used to form a good general opinion on the desirability of an import duty in any given instance.
Dumping of wheelbarrows
The recent case of the special import duty levied on wheelbarrows is an example of how an import duty may be justified on the grounds of trade policy, but actually amounts to a tax and a hidden subsidy. Not that one would by any means deny the fact that local producers often encounter stiff competition from producers in other countries, or even from producers in a different region of the same country, but one should consider very carefully how desirable import duties really are.
On 6 March this year the International Trade Administration Commission of South Africa introduced a special fee of between 29% and 33% on imports of certain wheelbarrows. The duty had been requested by Lasher Tools, a local wheelbarrow producer and distributor, after certain imported wheelbarrows had become so cheap that Lasher Tools was finding it extremely difficult to compete.
Lasher Tools accused the overseas producers of dumping. The World Trade Organisation’s definition of dumping is when a company exports its products to another country at a lower price than the price normally charged for those products in the home market. The technique, according to this theory, is that the overseas manufacturer uses a predatory pricing strategy of at first selling its product at a loss in a country such as South Africa until the local producers close shop, after which the overseas producer pushes up its prices higher than normal and thus makes an unfair and exorbitant profit.
Under the Customs and Excise Act of 1964, import duties in South Africa are levied on a wide variety of imported products. These duties are set out in numerous schedules of the Act, each running into hundreds of pages. The duties, expressly introduced to benefit local producers, amount to as much as 74% on certain chicken portions, 62% on frozen potato chips and 15% on car batteries. Garlic, kitchen sinks, unframed mirrors, shovels and forks, spark plugs, vehicles and many more do not escape the roving eyes of South Africa’s customs officials either.
Even though good reasons for doubt exist, this article will assume that tactics such are dumping are indeed employed and that South African producers have to change or scale down their activities from time to time because they sometimes find it tough to compete with manufacturers in other countries. We shall also not even ask whether it is desirable to protect such weaker local producers. Let us rather focus on the tax effect of import duties and the extent of the undeserved subsidy. For the sake of simplicity we shall confine ourselves to the wheelbarrow example.
The tax effect of import duties
The duties on wheelbarrow imports are initially paid by the importer. The importer is not the end user, however, and of course would increase his prices when selling the wheelbarrows in South Africa. As a result of the higher prices charged, the importer may recover part of the duty, but not necessarily all of it. The duty could be systematically spread along the value chain, so that in practice it may be partly paid by the importer, partly by middlemen and partly by the end user.
The fee levied on the wheelbarrow imports is a tax, because the government is the receiver and it is raked off the public’s transactions, just like VAT. In the wheelbarrow case the government receives about 30% of the import price of the wheelbarrows in question. Import duties, or customs and excise duties, constitute some 5% of government revenue in total. (Income tax, company tax and VAT make up between 20% and 35% each.)
Import duties as hidden subsidies
The government, which collects the import duty as tax, is not the only beneficiary of the duty, however. The other beneficiary is the local wheelbarrow producer, who can now proceed to charge more for his wheelbarrows than would otherwise be possible. While the government receives more tax, the local wheelbarrow producer receives more income as a result of his charging higher prices, but not because he added more value to society. Had the local wheelbarrow price not been kept artificially high, local buyers would have had more money with which to purchase other necessities, or more wheelbarrows, and everybody would have been better off.
So, even though the import duty was not transferred directly to the local wheelbarrow producer, there is in fact an intimation of a subsidy: the prices charged for the products of overseas competitors are raised artificially, which enables local wheelbarrow manufacturers to keep their prices higher in turn and so to undeservedly gain more income. Even if imports of the overseas competitor’s products completely cease due to the imposition of import duties, the local manufacturer is still able to charge higher prices and therefore the import duties continue to act as a tax on consumers.
The test for an equitable import duty
When would the introduction of an import duty be justified? There cannot be any doubt, after all, that local producers sometimes go through rough patches in the face of increased international competition, coupled with job insecurity and all kinds of instability. In these circumstances the temptation is strong to protect local producers by means of import duties.
A simple test can help to determine whether or not an import duty will be just. Key to the successful execution of the test is to combine the tax effect and subsidy effect of the import duty. The test is as follows: a local producer is in trouble, since a far-off producer is able to manufacture his product cheaper and better. Would it be fair to levy a tax on the general public and transfer the money to the local producer, so that he may lower his price without making a loss? If the local producer is indeed compensated with tax money, then he can after all make his product cheaper.
Such a test immediately demands great circumspection, however, since it is clear that the public as consumers, the public as tax payers and the local economy in general will be disadvantaged by such a system of transferring tax in the form of a subsidy to producers directly. Although import duties do not operate in the same direct fashion, they have the same effect.