That’s a great question, but the answer isn’t quite as simple as you (and I) might want it to be; there are a lot of moving parts involved, after all. The short answer is that, at this moment, nothing is happening with tariffs that impact the auto industry, though if the proposed 25% tariffs on cars and car components go through, then you can expect prices of vehicles to skyrocket. If you want the longer answer to this situation and how things are currently set, along with how they might play out, then keep reading because that’s what we’re talking about today. I’ll do my best to avoid too many unnecessary details and complex issues because we could be here all day digging into the minutia of everything that’s going on. But there will be some math.
What Are Tariffs and How Do They Work?
Before we go any further, it’s essential that we’re all on the same page about what tariffs are and how they work because this is something not everyone fully understands. Honestly, up until recently, unless you’re a politician, diplomat, importer, or work in international finance, you didn’t really need to know how tariffs work because it’s not something most folks deal with every day. But since they impact all of us, it’s important to know what they are.
A tariff is essentially an import tax placed on items coming into one country from another, generally based on the value of what’s being imported. This fee is paid by the company importing them into the country, which is not necessarily the company manufacturing them. In other words, let’s say you’re an American company that sells Product A for $100 each; you don’t make that product, you import it from Canada, and the manufacturer sells it to you for $50—that’s a basic markup of 100% to double your money. Now, there’s a 25% tariff placed on that product. The company that makes it does not pay this tariff; you, as the importer bringing it into the United States, pay that $25. This is very important because the manufacturer is not directly affected by this, though they can be if the loss of profit for the importer is enough that they decide to stop importing the product.
What’s Going On With Tariffs Right Now?
Now that we have that out of the way, right now, President Trump is using tariffs as a way to conduct international diplomacy. In order to put pressure on other countries, he is implementing tariffs in hopes that the potential economic harm will encourage them to adopt policies more favorable to the United States. He has stated that he is using the tariff on Mexico, for example, as punishment until the Mexican government does more to curb illegal immigration and the movement of fentanyl into the United States from Mexico.
Tariffs were supposed to be put in place at the beginning of February, but negotiations put a pause on that for one month. On Tuesday, March 4th, President Trump imposed a 25% tariff on almost all goods coming into the United States from both Mexico and Canada. This includes cars and components used in manufacturing vehicles here in America. The next day, March 5th, the White House announced a one-month reprieve on the tariffs for American car companies (more on this in a moment). The day after that, March 6th, additional exemptions were issued for more goods that are compliant with the United States-Mexico-Canada Agreement (USMCA), a trade agreement that was established during President Trump’s first term in office.
These exemptions are currently set to last until April 2nd. At that time, if nothing has changed, then they will end, and the full 25% tariff will once again go into effect for most goods moving from Mexico and Canada into the United States. Again, that would include a huge number of vehicles manufactured in Mexico and Canada, along with components brought from those countries into the United States for manufacturing here. However, only time will tell what will actually happen on April 2nd.
The Automotive Exemption to the Tariff Situation
I mentioned an exemption for car companies that went into effect the day after the tariff became active, which is where we’re at right now. The exemption is pretty straightforward: as long as American car companies abide by rules established in the USMCA, then they don’t have to pay the tariffs during this exemption period. These rules include that the regional value content (RVC) of passenger vehicles, light trucks, and core auto parts must have 75% North American content. Additionally, 40%-45% of a vehicle’s production by value must be made by workers earning at least $16 per hour, and 70% of a vehicle’s steel and aluminum by value must originate in North America. The Big Three (Ford, GM, and Stellantis) have all stated they were already following these rules, making it easy for them to take advantage of the exemption.
However, a couple of things need to be clarified here. First, RVC refers to the percentage of a vehicle’s value that doesn’t include materials from other countries or regions, so passenger vehicles need to have 75% of their materials used in production coming from North America. And second, if you’re paying attention, you might notice that I just referred to “North America” a couple times, not “the United States.” That’s because according to this trade agreement overseen by President Trump in his first term and used to qualify for the tariff exemption now, it’s entirely fine for that 75% of materials or 70% of steel and aluminum to come from Mexico or Canada—it doesn’t have to come from the United States. However, for now, there are no new tariffs for cars coming into the United States from Mexico or Canada as long as these rules are followed.
What Happens if Tariffs Are Enacted?
That’s the big question, isn’t it? I can’t answer with absolute certainty, but I can tell you this: there are generally three possible ways for a company dealing with a tariff to handle it in the short term. One, they can pass the added costs along to their customers to offset the rising expenses. Two, they can offset those rising expenses by cutting costs elsewhere (usually firing workers). Three, they can simply accept lower profits as a consequence. I don’t know which of those three options car companies will choose, but I would be very surprised if it was the last one.
In other words, the most likely outcome of car companies suddenly dealing with a 25% increase in their costs is to drastically increase the price of the vehicles they sell or to reduce their workforce. Or, even more likely, we could see both higher prices for cars and workers losing jobs. Also, keep in mind that we learned very clearly during COVID that increased prices for new cars quickly spills over into the used car market, so every vehicle would end up costing more, not just the new ones coming into the country. However, to be clear, this purely focuses on the short-term effects. In the long term, companies can avoid tariffs by simply importing fewer vehicles and building more of them here in the United States—and manufacturers from Honda to Porsche have already been talking about doing exactly that.
The Real Cost of Tariffs
Finally, it’s important to address something that people often misunderstand: it won’t just be an increase in price of 25%. Let’s say a car company currently spends $10,000 making a vehicle and then sells it for $20,000 (purely for example)—that’s a 100% profit. Now, that company has to pay a 25% tariff based on its value, which is to say $5,000; so now, that vehicle essentially costs the company $15,000 to make and sell. Businesses generally look at profits as percentages, not raw numbers, so they’re not going to sell it for $25,000 to recoup that expense because that would mean making less profit on it. They’re going to sell it for $30,000, so they still make that 100% profit—that’s the real cost of tariffs for consumers. Combine those increased prices with workers losing their jobs to offset rising costs for companies, and you could have a bad situation until the market sorts itself out.
