04 Apr
Member News, Trade & TTIP Related

Transatlantic Trade Monitor: Facts You Need Now | Impact of U.S. Tariffs on EU Manufacturers and Exporters

By Matthew Bock, Managing Partner, BOCK TRADE LAW

On April 2, 2025, the U.S. implemented a sweeping tariff regime via an executive order, introducing a baseline 10% tariff on goods from all countries, effective April 5, 2025, and higher reciprocal tariffs on specific trading partners, including the European Union (EU), effective April 9, 2025.  For the EU, the reciprocal tariff rate was set at 20%, reflecting the U.S. administration’s intent to address perceived trade asymmetries and a significant goods trade deficit, which reached $235.6 billion with the EU in 2024.

Economic and Operational Impacts

  1. Increased Costs for EU Exporters: The 20% reciprocal tariff, applied on top of existing duties, significantly raises the cost of EU goods entering the U.S. market.  Key sectors such as pharmaceuticals (the top EU export to the U.S., valued at over $60 billion in 2024), automotive (e.g., Mercedes, BMW, Volvo), which will largely be subject to a separate automotive/automotive parts tariff of 25%, and consumer goods (e.g., wine, spirits, olive oil) face higher landed costs, potentially reducing competitiveness against U.S.-produced or tariff-exempt goods (e.g., USMCA-compliant products).
  2. Reduced Export Volumes: Higher prices may dampen U.S. demand for EU goods, particularly in price-sensitive categories.  For instance, EU automotive exports, subject to the aforementioned separate 25% tariff on vehicles effective April 3, 2025, and luxury goods like cognac ($1.3 billion in 2024 imports), could see significant volume declines if costs are passed on to consumers.
  3. Supply Chain Disruptions: EU manufacturers reliant on integrated transatlantic supply chains, such as those in chemicals, machinery, and medical devices, may face disruptions as U.S. importers seek alternatives to mitigate tariff costs.  This is compounded by the EU’s $531.6 billion in goods exports to the U.S. in 2024, representing 19.7% of its total extra-EU exports.
  4. Retaliatory Measures: The EU has signaled retaliatory tariffs, with plans to reinstate suspended duties on $6 billion of U.S. goods (e.g., motorcycles, bourbon) by mid-April 2025 and potentially target an additional $18 billion in U.S. exports (e.g., steel, poultry, dairy).  This escalation could further strain EU exporters by limiting U.S. market access indirectly through broader trade tensions.
  5. Sector-Specific Vulnerabilities: The chemicals industry, with a high specialization in U.S. exports (26% of its total exports), and pharmaceuticals (e.g., weight-loss drugs from Ireland and Denmark) are particularly vulnerable due to low pre-existing tariffs (around 1%) and the significant cost increase from the new 20% rate.  Similarly, machinery and optical devices face challenges due to their export reliance on the U.S. market.

Reciprocal Tariffs Announced on April 2, 2025: Details and Basis

The executive order, issued on April 2, 2025, invokes the International Emergency Economic Powers Act (IEEPA) to declare a national emergency over the U.S.’s $1.2 trillion goods trade deficit in 2024, up 40% over five years.  It targets “asymmetries in trade relationships” contributing to the “atrophy of domestic production capacity,” particularly in manufacturing and defense-industrial sectors.  The EU’s 20% reciprocal tariff rate is part of a broader framework setting country-specific rates (e.g., 34% for China, 46% for Vietnam) to counter both tariff and non-tariff barriers.

Calculation and Basis

  1. Trade Deficit Proxy: The U.S. administration’s reciprocal tariff rates are not a direct mirror of EU tariffs but are instead derived from bilateral trade deficits adjusted by export volumes.  For the EU, the 2024 trade deficit of $235.6 billion divided by EU exports to the U.S. ($531.6 billion) yields a rough ratio of 44%, with the 20% tariff rate set at approximately half this figure.  This approach, criticized by economists as arbitrary, aims to “balance” trade rather than match specific EU tariffs (e.g., 10% on U.S. cars vs. 2.5% on EU cars).
  2. Non-Tariff Barriers: The executive order also factors in non-tariff barriers, such as the EU’s Value-Added Tax (VAT) system (averaging 20%), which the U.S. deems an unfair trade practice despite its non-discriminatory application.  Other cited barriers include EU regulations on packaging waste, deforestation, and digital markets (DMA/DSA), though these are not quantified precisely in the tariff calculation.
  3. Elasticity Assumptions: The U.S. Trade Representative’s methodology assumes an import demand elasticity of -4 and a tariff passthrough rate of 0.25, suggesting that a 20% tariff would reduce EU imports significantly without fully passing costs to U.S. consumers.  This conservative approach aims to shrink the trade deficit by curbing imports rather than aligning tariffs directly with EU rates.
  4. Legal Justification: By invoking IEEPA, the administration bypasses Congressional approval, framing the tariffs as a national security measure tied to military readiness and economic resilience.  This broadens the scope beyond traditional trade law (e.g., Section 301) to include systemic trade imbalances.

Critique of Reciprocity

The EU contests the “reciprocal” label, noting that its average applied tariff (3.5%) is comparable to the U.S.’s (3.95%), with sector-specific differences (e.g., 25% U.S. tariff on EU pickup trucks) ignored in the calculation.  The 20% rate thus exceeds a true mirror of EU tariffs, reflecting a protectionist rather than equitable intent.

Tariff Mitigation Strategies

EU exporters and U.S. importers can employ several strategies to reduce the dutiable value of merchandise, mitigating the impact of the 20% reciprocal tariff.  These strategies focus on lowering the Cost of Goods Sold (COGS), leveraging customs programs, and refining valuation practices.

  1. Reducing COGS in Intercompany Transfer Pricing
    • Strategy: Adjust transfer pricing between related EU and U.S. entities to lower the invoice value of goods sold to the U.S. affiliate.  For example, an EU manufacturer could reduce the markup on goods sold to its U.S. subsidiary, shifting profits to the U.S. entity via lower COGS.
    • Impact: If an EU exporter sells a product with a $100 COGS and a 20% markup ($120 invoice), reducing the markup to 10% ($110 invoice) lowers the tariff from $24 to $22 per unit, saving $2 per unit.  This requires alignment with U.S. and EU tax authorities to avoid double taxation or audits.
    • Challenges: Transfer pricing must comply with OECD guidelines and U.S. Customs Service scrutiny to ensure the transaction reflects an arm’s-length price.
  2. Leveraging the First Sale for Export Program
    • Strategy: Under the U.S. “First Sale” rule, duties can be assessed on the price of the first sale in a series of transactions (e.g., between an EU middle entity and a Chinese factory) rather than the final sale to the U.S. importer, provided the goods are destined for export to the U.S. and documentation is robust.
    • Impact: If an EU middle entity purchases goods from a Chinese factory for $80, and then sells such goods to a U.S. importer for $100, declaring the $80 “first sale” value reduces the tariff from $20 to $16 per unit (at 20%).  In 2024, this saved importers significant duties on apparel and electronics from the EU.
    • Implementation: Requires detailed records (e.g., contracts, purchase orders) proving export intent and may involve restructuring supply chains to insert a qualifying intermediary.
  3. Unbundling Non-Production Costs from Declared Value
    • Strategy: Exclude non-dutiable costs—such as design, R&D, marketing, or post-importation services—from the customs value.  For instance, an EU pharmaceutical firm could separate R&D costs (incurred in the EU) from the production cost of drugs exported to the U.S.
    • Impact: If a $100 product includes $20 in R&D and $80 in production, declaring only the $80 production cost cuts the tariff from $20 to $16 per unit.  This can be significant for high-value goods like medical devices ($59 billion in 2024 EU exports).
    • Requirements: U.S. Customs requires clear documentation distinguishing dutiable (e.g., materials, labor) from non-dutiable costs, and the unbundled costs must not be tied to the physical goods’ production.

Additional Strategies

  • Foreign Trade Zones: Store goods in U.S. Foreign Trade Zones (FTZs) to defer or avoid duties and tariffs (e.g., if goods are re-exported from the United States without ever entering U.S. commerce).
  • Supply Chain Diversification: Shift production to USMCA countries (e.g., Mexico) to leverage tariff exemptions, though this involves long-term investment.
  • Negotiation and Advocacy: EU firms could lobby for exemptions or reduced rates if trade talks resume, as hinted by the U.S. administration’s openness to “breaks” for cooperative partners.

 

Compliments of Bock Trade Law – a member of the EACCNY