Ad Valorem Duties Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Ad valorem duties are duties that are a fixed percentage of the price of the imported good. While conceptually straightforward, the administration of ad valorem duties may be complex, reflecting the practical difficulties in establishing the value of imported goods.

An ad valorem duty, or tariff, is in contrast to the specific tariff, which is a flat rate tariff that is independent of the value of the import. Ad valorem duties, unlike specific tariffs, are flexible and adjust to changes in the price or the value of the import good. If the ad valorem tariff rate is 5 percent and the import price is $100, the tariff revenue would be $5. If the import price increases to $150, then the per unit tariff revenue would be $7.50. With an initial specific tariff of $5 and an import price of $100, the ad valorem tariff and the specific tariff are equivalent. However, once the import price increases to $150, the specific tariff of $5 translates into a tariff rate of 3.3 percent. This reduces the level of protection that domestic producers receive from the tariff structure.

The ad valorem duty regime not only maintains the level of protection that domestic producers receive, it also increases the per unit import tariff revenue that the government receives when import prices are increasing. Ad valorem tariffs are therefore preferable to specific tariffs because they better achieve two of the primary aims of tariffs—namely, protecting domestic firms and rising tariff revenues.

Administration of ad valorem tariffs requires two factors: the first is the ad valorem tariff rate and the second is the value of the import good. Key to answering the first question is the appropriate tariff classification for the import. Tariff classification may be critical as a change in classification may either lower or raise the ad valorem tariff rate. This is the first step in the customs valuation process. The second step in this process is determining the value of the import good.

The value of the import good may be affected by the method used to determine the value of import goods. There are three import valuation methods that are frequently used: Free Along Price (FAS)— the price in the foreign market; Free on Board (FOB)—the price in the foreign market plus the cost of loading the good onto transportation at its port of origin; and Cost, Insurance, and Freight (CIF)—the cost in the foreign market plus insurance and freight costs incurred in delivering the good to its final destination port. In applying ad valorem tariff rates, the United States has traditionally used FOB valuations while European countries have traditionally used CIF valuations.

Determining the import valuation basis does not fully resolve the question of correct import valuation. One further difficulty is that the price of the import good in the foreign market, which affects import prices independently of the valuation method used, may constantly change. This variability in the foreign market price complicates the task of establishing the value of the import good.

With ad valorem tariffs, the tariff rate and import value jointly determine the import duties that are payable. Companies, therefore, have an incentive to shop custom classifications in order to reduce the tariff rate, and to under-invoice their imports in order to reduce the tariff rate. These incentives further complicate the process of administering ad valorem tariffs.

Bibliography:

Mohamed Hedi Bchir, Sebastien Jean, and David Laborde, “Binding Overhang and Tariff-Cutting Formulas,” Review of World Economics (v.142/2, July 2006);
Robert J. Carbaugh, International Economics, 11th ed. (Thomson Southwestern, 2007);
Charles Sawyer and Richard L. Sprinkle, International Economics, 3rd ed. (Pearson Prentice-Hall, 2009).

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