A Mysterious Pencil Factory Sharpens Focus On Tariff Scams

The search for the origin of the pencils led to a dusty factory in the Philippines.

An American investigator traveled there last year, trying to find out if the factory really produced the pencils, as a U.S. importer claimed, or was simply repackaging pencils from China, as a competitor suspected. Chinese pencils have long been subject to a stiff anti-dumping tariff, which would have more than doubled the importer's cost.

An unannounced factory visit yielded damning evidence. According to a U.S. customs report, the manufacturing equipment at the Philippine plant "appeared to have been covered in dust and cobwebs indicating that they had not been used for some time."

The inspector saw no evidence of manufacturing, though some pencils were being sharpened. And there were boxes and boxes of finished pencils, with labels saying they were made in China.

The inspector "witnessed staff repacking what appeared to be Chinese origin products into boxes labeled 'Made in Philippines,' " the report said.

Mislabeling the source of products to avoid tariffs is not a new scam. But it's likely to grow more prevalent as the trade war between the U.S. and China drags on and tariffs are extended to nearly everything China exports. Each new brick in the president's tariff wall brings new incentives for unscrupulous businesspeople to tunnel under.

Customs officials say plenty of suppliers in China are willing to help customers avoid those tariffs by falsely claiming their products are manufactured elsewhere. Sometimes, the goods are actually shipped to that third country on their way to the U.S. to add a veneer of legitimacy.

"It's no secret. It's definitely an open cottage industry in China, big time," said a spokesman for U.S. Customs and Border Protection, who spoke on condition of anonymity to discuss tariff enforcement policy. "It's not uncommon to hear stories of Chinese brokers charging a nominal extra fee to somebody to essentially say, 'Don't worry about it. I'll make sure it doesn't say 'China' on it.' "

Roberto Durazo helps set up factories in Mexico. Lately, he has been getting a lot of calls from Chinese companies eager to avoid the mounting import taxes imposed by the Trump administration.

"They tell us, like, 'Hey, I build a TV,' " Durazo said. " 'And I want that TV to be made in Mexico so I [don't have to] pay the duties.' "

Durazo is happy to help firms that actually want to relocate their manufacturing to Mexico. But some don't want to go that far. They want to keep making TVs and other products in China but pass them off as made in Mexico to avoid paying the tariffs.

"They just want to put it in the box, add labels and claim that it's made in Mexico," Durazo said. "And we tell them it doesn't work like that."

Sometimes, however, it does work like that, because not everyone is as honest as Durazo is.

Attorney Benjamin Bucy says he's seeing more of these cases as tariffs on Chinese imports mount. Bucy co-authored a law review article last year called "Trade Fraud: The Wild, New Frontier of White Collar Crime."

Often, he says, it's up to competitors to blow the whistle.

"If they're paying a 25% tariff and being undercut by someone where they know the export price and the tariff price in something isn't matching up, that's often the kind of knowledge that a competitor uses to build a case," Bucy said.

The search of the Philippine factory last year began when Dixon Ticonderoga filed a complaint with Customs and Border Protection about one of its competitors, Royal Brush Manufacturing. Dixon Ticonderoga suspected that Royal Brush was buying cheap Chinese pencils but claiming they were made in the Philippines to avoid paying the anti-dumping tariff of 114.9%.

After a 14-month investigation, customs agreed, and Royal Brush was ordered to repay the avoided tariffs. The company is appealing the customs ruling and has stopped doing business with its Philippine supplier.

"This has been a costly, time-consuming, really psychologically painful process," said Ronald Oleynik, Royal Brush's lawyer. "They're struggling to clear their name."

Oleynik conceded that his client may have been duped along with everyone else about the origin of the pencils. It's hard to know for certain when a supplier's "factory" is an ocean away.

"The Trump administration, I keep saying, doesn't have a trade war. It's in some ways got a war on trade," Oleynik said.

Bucy, who often represents companies bringing complaints about tariff evasion, argues that whatever one thinks of the president's trade war, scofflaws should be pursued.

"Once those laws are passed and law-abiding importers or others are subject to paying those, then those laws need to be enforced," he said.

Foreign suppliers often make little effort to cover their tracks. Customs officials say that in some cases they find only a vacant lot where a factory is supposed to be.

"These unscrupulous actors in some of these foreign countries are not used to scrutiny," Bucy said. "They're not expecting to be investigated at all."

Nevertheless, customs officials say vetting the growing number of complaints is a challenge.

When the U.S. imposes tariffs on China, it's only natural that some production really does move to other countries. Customs investigators grow suspicious when they see what appear to be abrupt moves, especially those that involve complex manufacturing or heavy machinery.

"If on Monday a company is sourcing all their product from China and on Tuesday all of it is suddenly now coming from Vietnam or some other country, depending on the nature of the commodity, that's just not realistic," the customs spokesman said. "If that abrupt shift occurs the day after Chinese tariffs are raised, that's another indicator."

U.S. imports from Vietnam jumped 33% in the first seven months of the year, compared with the same period a year ago.

Policing tariff fraud in far-flung places is expensive, and even when the customs cops succeed in shutting down one fraudulent "factory," another pops up to take its place, much like a game of whack-a-mole.

"There are no strong consequences, at least in their home country," said University of North Carolina economist Patrick Conway, who has followed tariff enforcement for decades. "It is difficult to have a long-term impact, even if you find evidence of an almost open-and-shut case."

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