A clear policy position on tariffs has been a long-running absence from the Government’s No Deal planning; the question has been repeatedly kicked down the road. The EU exit sub-committee of Cabinet ministers was due to meet and finalise a policy position on Monday, but this has now been delayed until after this week’s crunch votes in Parliament.

When the tariff policy does finally emerge, it will likely be a compromise which reflects a series of international and domestic trade-offs.

WTO rules on tariffs explained

The Government’s policy on tariffs in a No Deal Brexit will be constrained by WTO rules, in particular the Most Favoured Nation (MFN) principle.

  • In the absence of a preferential trade agreement with the EU, the MFN principle means the UK and EU27 can no longer discriminate in each other’s favour as far as tariffs are concerned.
  • As a result, maintaining tariff-free imports from the EU would only be an option if the UK opted for unilateral liberalisation of tariffs with the rest of the world as well. This would expose domestic industry to cheaper imports from third countries, such as China, though it would also reduce the tariff burden on consumers.
  • These MFN constraints also apply to the EU, which is likely to apply its MFN tariffs to UK imports in full if there is No Deal.
  • It has been argued that the UK and EU can maintain zero-tariff trade on an interim basis without unilateral liberalisation, utilising Article XXIV of the General Agreement on Tariffs and Trade (GATT). However, this rests on a misunderstanding of Article XXIV, which cannot be triggered unilaterally – it requires EU agreement, and therefore is not an option in a ‘No Deal’ scenario.

However, within the constraints of the MFN principle, the UK will retain flexibility on its overall tariff regime – thanks to the distinction between ‘bound’ and ‘applied’ tariff rates.

  • WTO members commit to a ‘bound’ tariff rate. This sets a ‘ceiling’ on the MFN tariffs levied on imports of any given product.
  • Since bound tariffs are a ceiling, they are not always the same as the ‘applied’ tariff which a WTO member actually levies in practice.
  • WTO members therefore have flexibility to increase or decrease their tariffs within the constraints of the bound ‘ceiling’ – so long as this is non-discriminatory, as per the MFN principle. The UK inherits the EU’s bound tariff rates following EU membership.
  • As such, it is not necessarily the case that unilaterally liberalising the UK’s applied tariffs would undermine the UK’s negotiating leverage in future trade deals. Only the liberalisation of the bound ceilings would be permanent. Whatever the government decides this week will be an interim policy for No Deal – not necessarily a permanent commitment to a particular policy on tariffs.

The Government’s options span from full protectionism to unilateral liberalisation

The status quo – mutual tariff-free trade with the EU and some tariffs on non-EU trade – is not an option under No Deal. There is a spectrum of options the Government could theoretically pursue on tariffs:

  • Replicate the EU’s Common External Tariff: As a member of the EU, the UK currently charges the EU’s Common External Tariff (CET) on goods imports from third countries. The UK could replicate this on EU imports when it becomes a third country. This would generate additional revenue for the exchequer – currently 80% of UK tariff revenue goes into the EU budget. However, this ‘tit-for-tat’ protectionism would involve levying a regressive tax on importing businesses and consumers.
  • Revenue neutral equilibrium: Rather than replicating the CET, the UK could levy moderately higher EU tariff revenues while reducing overall tariff rates. For example, the UK currently charges the EU external tariff of 11.8% on clothing imports from third countries, whereas EU clothing enters the UK tariff free. Next plc – where Open Europe’s Chairman, Simon Wolfson, is CEO – has found that if the UK set a new applied tariff rate at 5.8% on clothing across all imports from the EU and the rest of the world, this would prevent overall increases in tariff costs for importers and protect revenue levels for the exchequer.
  • Targeted tariff liberalisation: This sector-specific approach involves adjusting tariffs so as to deliver cost reductions for consumers in some areas, while protecting domestic producers in others. Tariffs would only be lowered or removed in sectors with limited domestic producer exposure to foreign competition. The Institute for Fiscal Studies (IFS) found that this could see consumer prices fall by 0.2-0.4%.
  • Full unilateral liberalisation: This would mean removing tariffs entirely across the board, either on a temporary or permanent basis. This would remove many burdensome border operations relating to tariff collection, and could reduce the prices of consumer goods – though the UK Trade Policy Observatory found the price effect would be relatively small. However, full liberalisation would be politically controversial, and would also expose domestic producers to new foreign competition. Unsurprisingly, the Government has ruled out this option.

The Government looks set to pursue targeted tariff liberalisation, which will vary sector-by-sector

The broad contours of government policy were agreed two weeks ago. There is broad agreement to avoid imposing tariffs on most imports in the short-term, in order to minimise disruption to trade flows, but support for “limited exceptions” to this in order to protect vulnerable sectors such as agriculture. A recent exclusive in the Financial Times appears to confirm this sectoral approach. However, there has reportedly been disagreement within the Cabinet over the level of tariffs in these import-sensitive sectors, and whether to prioritise protections for producers or avoiding higher prices for consumers.

The sector most likely to be protected by tariffs and quotas is agriculture, where EU tariffs are very high – up to 40% for some meat products. Michael Gove told the National Farmers Union (NFU) last week, “I can reassure you it will not be the case that we will have zero rate tariffs on [farming] products.” This came after lobbying from the NFU, with its president Minette Batters telling the BBC, “If you obliterate the tariff wall… we would be massively undermined by food produced to standards that would be illegal to produce to in this country. It would decimate British agriculture.”

However, agriculture is not the only sector which has lobbied for tariff protection. For example, the British Ceramic Confederation (BCC) sent a letter to the Prime Minister this week saying, “the shock of zero tariffs would be devastating, affecting business, jobs and communities across the country.” The aforementioned Financial Times report suggests that ceramics, as well as steel and cars, are set to be protected by tariffs in a No Deal scenario.

Separately, the Government has already announced that it will keep 43 EU anti-dumping measures in a No Deal Brexit, while a further 66 will not apply as these have been judged not to matter to UK businesses. Many anti-dumping measures, such as countervailing duties, are effectively additional tariffs imposed on imports judged to be traded unfairly. The Department of International Trade is in the process of establishing a UK Trade Remedies Authority for this purpose.

The announcement may also set out the Government’s plan for tariff rate quotas in No Deal, an issue on which there has been little clarity thus far and which has previously faced stumbling blocks at the WTO.

The Irish border question hangs over the government’s policy on tariffs

The decision to impose tariffs, at any level, on EU agricultural produce raises a familiar problem: the Irish border. Given the Government’s commitment to avoid border checks in Northern Ireland even in the event of No Deal, tariff collection could be problematic. There are three broad possibilities, none of which are particularly palatable:

  • Collect tariffs in Northern Ireland. There are ways to conduct this away from the border, but this would still be politically problematic given the sensitivities in the region.
  • Collect tariffs at Irish Sea ports. While avoiding a hard land border, this risks angering Unionists and disadvantaging Northern Irish farmers exporting to Great Britain.
  • Not collecting tariffs on food imported via Northern Ireland. This would sit uneasily with a policy of levying tariffs on EU imports at other entry points, and opens the risk of trade diversion via Northern Ireland.

Whichever option the UK takes, the problem of the border cuts two ways in No Deal, and the Irish government will face its own set of difficult choices on tariff collection.

Any tariff option the Government pursues will face political opposition

The decision to delay the announcement on tariffs until after this week’s votes reflects the fact that any announcement on tariffs will be politically controversial. In the words of one Cabinet source, the Government “worry that Brexiteers will see it as another bit of Project Fear while anti-Brexit MPs will see as proof that No Deal has to be taken off the table.” Increased tariffs will be criticised for the impact on consumers; lower tariffs for the impact on producers. Either option will be compared unfavourably to the status quo by Remainers. Ultimately, however, facing up to these difficult trade-offs is part and parcel of an independent trade policy.