Who benefits from tariff reductions? - Mike Moffatt

Benefits passed on but it's complicated.

I was invited to appear in front of the Standing Senate Committee on National Finance on the subject of tariff reductions on baby clothes and sporting equipment. My testimony follows below.

My name is Mike Moffatt and I hold the rank of Assistant Professor in the Business, Economics and Public Policy group at the Richard Ivey School of Business.

I have researched and taught economics and international trade for a number of years at Ivey, as well as spending the last eight years as a private sector trade and regulatory consultant to the chemical industry. I am representing myself today. I would like to thank the committee for inviting me.

I am here today to discuss the elimination of tariffs on baby clothes and sporting equipment as given in Part 3, Division 1, Clauses 62 to 103 of Bill C-60. I am in full support of these changes.

These changes will help alleviate the Canada-USA price gap that was the basis of the fine report issued by this committee. This price gap is important for two reasons. The first is that higher retail prices lower the well being of Canadian consumers. The second is that the price gap leads to higher levels of cross border shopping, causing a hollowing out of the Canadian retail sector, particularly when those price differences are due to Canadian retailers having higher costs than their American counterparts. Reducing tariffs addresses both of these issues, as it lowers the costs borne by Canadian retailers, which will almost certainly cause a reduction in Canadian retail prices.

In particular, I am a supporter of the list of products that are receiving tariff reductions. The tariff elimination on baby clothes is a particularly progressive measure, as these make up a larger portion of spending for lower income households. As an amateur athlete and the father of a two year old, I am delighted by these reductions on a personal level as well. I am hopeful that these changes will lead to future tariff reductions on items such as athletic apparel and running shoes.

I understand that the effects of these changes will be monitored closely, to see who receives the benefits from the tariff reductions. Since my testimony will be etched into the permanent record, this seems like a fine time to offer my predictions, based on my experiences as an economist and as a private sector consultant.

The direct beneficiary of lower tariffs is importers, as they are the ones required to pay those tariffs. However, part or all of these savings may be passed along upstream to foreign manufacturers, or downstream to retailers and consumers. Or, in economics speak, the economic incidence from taxation often differs a great deal from the legal incidence.

In theory, foreign manufacturers could benefit from the tariff reductions as follows – reducing the tariff on, say, baseball helmets increases the demand for those helmets. That increase in demand raises the world price for those helmets, causing the foreign manufacturer to benefit.

This seems highly unlikely in the context of the Bill C-60 changes. On a global scale, the Canadian market is simply too small to cause those kinds of changes, and size matters when influencing international prices. Many of these products are manufactured in China and Canada makes up only 2.4 percent of the Chinese export market. International historical evidence dating back to the Great Depression shows that it is quite difficult to pass the burden of tariffs along to foreign countries; I see no reason why our experience should be any different.

Canadian entities are going to be the beneficiaries of these tariff reductions, but the question remains which Canadian entities will benefit – importers, retailers or consumers. Large retailers tend to be their own importers, so I will focus on the question of retailers vs. consumers.

We can think of the tariffs as a sales tax, albeit it one hidden from consumers. The best evidence that we have on the economic incidence of sales taxes comes from a 1999 study by economists Timothy Belsey and Harvey Rosen. They find that, after an adjustment period, changes in sales taxes are fully passed along to consumers. In some cases, they find that the shifting is often greater than one-to-one, a phenomenon that was also discussed in the Senate report.

What ultimately determines how much will be passed along to consumers is the level of competition. Items such as hockey helmets and baby clothes are sold at a variety of competing retailers, so expect savings to be fully or near-fully passed along to consumers and prices to be adjusted over one or two sales cycles. For more esoteric items such as baseball pitching machines and cricket bats, the market is less competitive so retailers may be able to retain a significant portion of the savings and prices will take longer to adjust. We cannot forget, however, that much of the competition faced by retailers in border regions comes from cross border shopping, which makes the retail market even more competitive than it would appear at first glance.

My only concerns about recent tariff proposals are deal with a Budget 2013 item not in Bill C-60. The changes to the General Preferential Tariff system and the associated 350 million dollar per year tariff increase more than undoes the benefits of the reductions on baby clothes and sporting equipment. While I agree the system needs modernizing so that countries such as China and South Korea do not receive special treatment, there are ways of doing so that do not raise tariffs.

Finally, I believe that concerns that retailers may use the tariff reductions to increase their profits are somewhat misplaced. Profit should not be considered a four letter word. With high retail vacancies in Southwestern Ontario and an unemployment rate of 9.6 percent in Windsor, Ontario, a stronger and more profitable retail sector should be desired, not feared.

Thank you for your time.

Mike Moffatt is an assistant professor in the Business, Economics and Public Policy group at the Richard Ivey School of Business, University of Western Ontario