By Paul Ziobro and Richard Rubin

Mattel Inc., Hasbro Inc. and other U.S. toy makers are bracing for an overhaul of the U.S. tax code that is likely to hit especially hard an industry long reliant on overseas labor to manufacture Barbie dolls, Nerf guns and Hot Wheels cars.

A proposal to apply a border adjustment to the U.S. corporate tax would strip toy makers of the ability to deduct the cost of imported goods from their profits, potentially forcing major price increases. The proposal, still in early stages, aims to cut tax rates and keep jobs in the U.S. But the implications are challenging for an industry that sells many of its products in the U.S. while producing nearly all of them overseas.

Hasbro and Mattel both generate about half of their revenue domestically but roughly 95% of Hasbro products and 100% of Mattel's are made overseas, said Timothy Conder, a toy-industry analyst at Wells Fargo.

Other groups such as big-box retailers who mostly sell goods made overseas, are also on guard about the tax. But it could be particularly costly for U.S. toy companies: Their home market is their biggest in terms of sales, but with an average manufacturing cost of $10 per toy, the U.S. isn't a cost-effective place to produce them.

Mr. Conder estimates that the proposed tax change, under a worst-case scenario, could lower toy maker Mattel's 2017 earnings, which he forecasts to be $1.87 a share, by as much as 56 cents, and ding Hasbro's 2017 estimated profit of $4.76 a share by 62 cents.

Mattel, based in El Segundo, Calif., declined to comment. Hasbro, in Pawtucket, R.I., didn't respond to requests for comment.

The border adjustment, part of the Republicans' plan for a revamped tax system, would apply taxes based on where a product is sold rather than where it is made or where the maker's operations or executives are based. Imports couldn't be deducted as a cost of doing business, while exports would be exempted.

For instance, if a company imports $1 million of foreign-made toys, spends $500,000 on domestic costs and sells the products for $2 million, it would only be able to deduct the $500,000 in local costs under the proposal. Thus, it would pay taxes -- at the proposed lower corporate tax rate of 20% -- on $1.5 million. A similarly situated company now would deduct all the costs and pay 35% in taxes on just the $500,000.

Economists say that the tax change would help push up the dollar -- which would in turn lowering the cost of imports and help to offset the extra taxes.

According to Douglas Holtz-Eakin, a Republican economist, some of importers' concerns are overblown, and they aren't factoring in the benefits they would get from stronger economic growth and the rising dollar. Companies and analysts looking only at what the corporations pay in taxes are analyzing the plan incorrectly, he said.

"Your cost of doing business won't change," Mr. Holtz-Eakin said. "It will consist less of the cost of imports, which will be cheaper, and more in taxes.

But large importers doubt that will happen as smoothly as projected. The tax code has long allowed companies to deduct costs for business purposes without a distinction between domestic and foreign goods.

Importers are fighting the still-developing plan in Washington, and Republican senators and the incoming administration of President-elect Donald Trump haven't embraced it. House GOP members, though, see itas a key pillar of their proposal, because it provides roughly $1 trillion over a decade to offset proposed corporate tax-rate cuts.

U.S. toy makers decamped to Asia decades ago for its cheaper labor and manufacturing. Companies refined their operations over the years as their design and engineering capabilities improved, and modern highways and ports proliferated in China, making it easier for companies to move raw materials and finished goods around the world.

"It really morphed into what you would call the toy industrial complex," said Richard Gottlieb, founder of Global Toy Experts, a consulting firm, of the production facilities in China. "You have something of a scale that's not repeatable in the world."

Some toy makers warn that attempting to bring it back to the U.S. would be an expensive undertaking. Isaac Larian, chief executive of MGA Entertainment Inc., the Los Angeles-based maker of Bratz dolls and other toys, saidthat moving production domestically would force the company to triple its prices.

"U.S. consumers will not accept it," he said in an email.

Mr. Larian said his company does make some products for its Little Tikes line in a Hudson, Ohio, factory, and it has invested millions in new machinery to ramp up its output there. He added, however, that retailers and consumers are reluctant to pay more for "Made in the U.S.A." products.

The Toy Industry Association, the industry's main trade group in the U.S., has been working with other trade associations that rely on imports in an attempt to sway Congress to drop the border-adjustment tax proposal, emphasizing that the $25 billion toy industry supports nearly half a million American jobs.

If that doesn't work, the New York-based association has promised to fight.

"We are fully prepared to work productively or be a royal, boisterous, media-friendly pain in the backsides of people who would take away children's happy birthdays, steal Christmas and destroy quality U.S.-based jobs," its president, Steve Pasierb, wrote last month in his year-end letter to members. "And no one wants to have to explain to their children why Santa was put out of work."

Write to Paul Ziobro at Paul.Ziobro@wsj.com and Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

January 11, 2017 09:14 ET (14:14 GMT)

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