In a paper released today at the Mowat Centre, I advocate for the selective elimination of tariffs—taxes—on imported goods as a way to boost Canadian productivity.
Making it Simple highlights the absurd, occasionally Kafkaesque, world of Canadian import tariffs and finds that while most tariffs raise next to no revenue for the government, they impose significant costs on Canadian businesses and consumers. While the tariff system is an incredibly complicated beast, the case for selective elimination of low-revenue tariffs can be summarized in ten simple points:
1. Only a few tariffs truly matter.
The Canadian government collects roughly $4 billion a year in tariff revenue, but only a handful of products such as cars, clothing and shoes generate a significant amount of money for the federal government. Combined half of all active tariffs (that is, tariffs with rates above 0%) generate just $100 million a year in revenue. This is due to a combination of low tariff rates and the imported products coming in tariff-free under free trade deals like NAFTA.
2. Compliance is expensive…
The term “free trade deal” can be misleading, as free trade is anything but free for businesses. The best estimates we have are that the compliance costs to importers and exporters of trading tariff-free under NAFTA are around (or above) 1% of the value of the goods sold. That is, a shipment of $100 million worth of goods costs the trading partners $1 million in regulatory compliance costs. Given that two-way trade between Canada and the United States was over $750 billion in 2015, even the most conservative estimates of compliance costs are in the billions.
3. …and so is giving up.
Due to these compliance costs, companies occasionally find it cheaper and easier to simply pay tariffs rather than attempt to import tariff-free under NAFTA or one of Canada’s other trade deals. This particularly affects small and medium-sized businesses, as they often lack the resources to navigate an incredibly complicated tariff system.
4. The paperwork is a nightmare…
Why are these compliance costs so high? One problem is that to import tariff-free under a trade deal, companies must be able to prove that the product meets the country-of-origin requirements of the trade deal. If a Canadian company is importing a good under our trade deal with Israel, they must be able to prove that the good underwent “sufficient production” in Israel to qualify for tariff-free status. These rules are incredibly complex, run hundreds of pages per trade deal, require the importer obtain and retain paperwork for a five-year period and expose the company to retroactive audits.
5. … so it’s filled with mistakes…
As well, companies must correctly classify their product using “Canada’s Customs Tariff, a 1569 page tome containing over 15,000 eight-digit tariff items”. As the paper indicates, companies often struggle with proper tariff classification as “the 2001 Report of the Auditor General of Canada revealed that 29 percent of tariff classifications provided by importers were incorrect, with 48 of the 53 companies examined making at least one error in classification”. The report gives the example of an electric toothbrush, which does not fall under the tariff item “toothbrush” but rather falls under the tariff item “electro-mechanical domestic appliance”. These mistakes can be quite costly for businesses, as differences in tariff rates mean that a company making a classification error will either pay too much in tariffs or face a retroactive tax bill if they accidentally classified a product at too low a rate.
6. …and complicated exceptions.
If this were not complicated enough, there are also complicated override provisions on tariffs which create even more headaches. These override provisions were at the heart of the iPod tax dispute, where the Canadian government paid out $27 million to electronics importers for improperly collected tariffs.
7. Even with all the rules, there’s no clarity…
Companies and the Canadian Border Services Agency (CBSA) often cannot agree on what the correct tariff item should be, with disputes making their way to the Canadian International Trade Tribunal (CITT). Some of these cases are quite absurd, such as Philips Electronics and the CBSA arguing over whether coffee and espresso are the same thing. In my favourite case, Mattel Canada and the CBSA debated the nature of the Rainforest Jumperoo, the Rainforest Bouncer and the Newborn to Toddler Rocker. In the case, “[t]he CBSA argued that these items are seats and fall under tariff classifications 9401.71.10 and 9401.80.10 which have associated tariff rates of 8 per cent and 9.5 per cent, respectively. Mattel argued that these items are toys, and should enter the country tariff-free under tariff item 9503.00.90… To help answer the question, the CBSA brought in Dr. Christopher Fennell, Associate Professor at the University of Ottawa, for his expert opinion on infant cognitive development. In order to be considered a toy, the Tribunal was required to determine if the goods could “be said to amuse infants or children”. Dr. Fennell testified that “…past the age of six months, I would be comfortable saying that these objects could provoke amusement at that higher level of smiling and laughing.” Ultimately the CITT sided with Mattel.” Given the tax consequences, companies spend millions on some of the best legal and scientific minds in the country to determine how much fun a child could have using a chair.
8. …And clarity is costly.
The taxpayer also pays for these cases, as the CITT’s budget is roughly $10 million a year, almost all of which comes from the federal government.
9. Eliminating Tariffs is a good deal.
Most of these costs are eliminated if tariff rates are simply set to zero. The country-of-origin problem goes away entirely, as companies would no longer need the protection of free-trade deals to import tariff free. While companies would still have to make good faith efforts to classify their products correctly, mistakes or disagreements in classification would no longer have tax consequences, removing the fears of audits and eliminating the need for CITT cases on the proper way to classify a trampoline enclosure. The productivity savings are in the billions, at a cost to the treasury of $100 million a year if 50% of tariff rates are set to zero and $600 million if 90 percent of tariff rates are eliminated.
10. We know it can be done.
There is a template for setting tariff rates to zero, as Budget 2009 and Budget 2010 eliminated tariffs on some manufacturing inputs as a way to boost productivity in the manufacturing sector. In the paper I recommend a similar process be followed, with the government also examining manufacturing inputs that were missed, including tariffs on metal tools and inputs used by the clothing and agrifood manufacturing sectors.
Given the low relatively small financial costs to the federal government, I hope they will consider selective tariff elimination. The first step would be to select possible tariff items for elimination (my paper suggests a number of candidates), announce their potential abolition in the Canada Gazette and receive feedback from stakeholder groups. Based on that feedback, the government could then eliminate some of those tariffs in Budget 2017. Given the need to boost Canadian productivity, I can see no reason why they would not consider doing so.
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