Avoiding Tariffs in a Trade War

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By Peter Keen

While the impacts of the inclusion of Chinese tea imports in the Trump Administration’s trade war are very unclear and the details labyrinthine, one certainty is that there will be tariff evasion. This is a sophisticated, pervasive and never-ceasing art form in world trade.

This brief on the main methods of evasion is not in any way an endorsement or tutorial. It is intended as information worth keeping in mind, especially since others’ evasion may affect US tea companies, in terms of authentication, quality, and liability. Trade in shrimp, wire hangers and even honey are rife with evasion, some of it creating health risks and including counterfeiting. Tea is just another and comparable trade good.

The main evasion strategy doesn’t tamper with quality but with identity: source of origin and product category. Here, exports from China are shipped to another country and then transshipped to the intended import nation, where the high tariff applies. It is, in essence, a sales tax triggered by “China.” Transshipment can detrigger it. Instead of the cargo vessel traveling by the most direct – and cheapest – route, it is sent to an intermediate port where its identity can be changed to the transshipment nation.

It’s easy for buyers to get caught in the falsification. One typical case was Chinese honey being transshipped to Thailand and depollenized to make it more difficult to detect the country of origin. The barrels were relabeled and reshipped to Canada and then trucked to Houston where it was sold to J.M. Smuckers and Sara Lee. Smuckers sold 12,000 cases to Ritz Carton Hotels before the evasion was uncovered.

There are many other instances concerning Chinese honey. Over an 18-month period in 2017-2018, the US imported more than 200 million pounds of honey, 60% of which comes from Asia, with multiple laundering ports. Taiwan, Malaysia, India, Sri Lanka, and the Phillippines are among the many known transhipment shipment port centers where a record of a false country of origin can be created fairly systematically and routinely. The simple concept exploits many complexities. Goods are categorized by a 10-digit international Harmonized Tariff Schedule HTS code (for instance, China oolong tea in immediate packings of less than 3 kilogram is 09023010 versus 09024010 for over 3 kg.) These are not exactly immune to substitution.

Studies have shown that evasion is often outsourced to intermediaries who manipulate cargo logistics in “entrepots.” These refer to duty-free ports with high volumes of re-exports. That may involve a large cargo from China being split up, some stored and most sent on to multiple importing nations. In the tea trade, New Orleans is the main US port and Dubai the largest globally. 

It’s difficult to guess at how tariff evaders will respond to the China tariffs. They will surely do so. Research studies show that even a 1% tariff increase on goods increases evasion activity by 0.6% for commodities and 2.1% for differentiated products.  The figures are hard to track and quantify – it’s closer to drug cartel trade than standard commercial trade, with secrecy at its core.

They can, however, be inferred from the value gap in trade. Exports of a category of goods from China are tagged at the port or border and again recognized as originating from China at the import point. The figures should match. They don’t and when tariffs hit, the gap expands. When the US slapped a tariff on large Chinese washing machines in 2016, its imports dropped by 96%, from $675 to $28 million. Somehow, Vietnam overnight found new manufacturing capacity to increase its own shipments to the US by 324%, Thailand by 216% and South Korea by 103% and, behold, thanks to the miracle of instant production the US import the same volume of machines, with just 4% identified as Chinese.

China tea will need some fine-tuning for effective evasion. There are two identities: bulk commodity and premium specialty. The commodity benefits from the various transshipment schemes. Hide the identity, route the goods via intermediaries through ports with no or much lower tariffs, downgrade the apparent quality and hence price. The premium tea demands maintaining the identity: an imported Keemum Mao Feng or aged Yunnan pu-ehr is special. The importer wants the name to be kept forefront, not obscured.

The shipment will be in small amounts and often sent by air since only a small percentage of packages are inspected. It’s relatively easy to disguise the country of origin by a simple tool already expanding in use: an Internet web site and a small foreign warehouse. Chinese firms are moving ordering and fulfillment online to other countries, such as Vietnam and even India. Maintain a small inventory there and “China” disappears from the order, invoice, package, and customs declaration.

One final ploy applies to many “differentiated” goods, ones that are closer to custom made than commodity. How do you calculate the cost of the China ingredients in a tea blend recipe which may include seasonal sourcing from 20 countries or more, with, say, Assam tea substituting for Kenyan or Malawi or Malaysian in the same “English Breakfast?” How do you separate the cost of the tea bag, packaging, and accessories in a gift package?

There’s an overall message running through all these examples: evasion relies on manipulating identity on the journey to the US, not at its start or endpoints. There’s a lot of discussion of transformation as a legal move in reducing evasion but that may be of less impact than blurring the issues along the way.