What is a Tariff?

Definition:

A tariff is a tax imposed by one nation on goods or services imported from another country.

🤔 Understanding a tariff

A tariff is a tax that a country imposes on the import of goods or services from another nation, often an attempt by the instigating nation to protect domestic industries and jobs, or to make a political move. Think of the U.S.-China trade war instigated by President Trump to fulfil his campaign promises to ‘get tough’ on China. A tariff usually results in a price increase for imported goods, which can be passed on to domestic consumers or absorbed by the manufacturer. Tariffs can be effective in protecting a domestic industry — but usually at the cost of higher consumer prices and slower economic growth overall for the country imposing them.

Example

The US car market includes brands from all over the world. Let’s say a hypothetical German car manufacturer chose not to set up a factory in the US but instead kept manufacturing in Germany. Since that car comes from overseas and through the US border, the US could choose to attach a tariff to that vehicle, which would make it more expensive to the US consumer.

In this fictitious example, let’s say the US imposed a 10% tariff on German cars, and the German manufacturer sold the car for $20,000. The total cost of the car would be $22,000, with the tariff $2,000 of that ($20,000 x 10%).

Takeaway

A tariff is like a tollbooth on international commerce…

If a country raises the toll to get in, the products going through the tollbooth will be more expensive.

Companies inside the country may be happy they don’t have to pay the toll; but everybody else inside the country who wants to buy the product will have to pay it instead.

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Why use tariffs and trade barriers?

Countries typically raise tariffs or erect trade barriers when they want to protect local industries or make a political point.

To protect local jobs: Tariffs can serve as a protective layer for local companies. If they can offer products cheaper than their overseas counterparts, then there’s usually a higher chance of people purchasing from the domestic producer. This can sometimes help spur job growth in the local area.

To ensure national security: A government will impose barriers to protect industries that it deems vital to protecting national security, such as defense industries.

Nascent industries: Governments sometimes impose tariffs on imported goods affecting an industry that it wants to develop domestically. That increases the price of imported goods and makes domestic products more attractive. One problem with this strategy is that the local industry could blossom without any competition, which can result in lower quality goods.

As a means to retaliate: Tariffs also serve as a retaliation technique. A country can impose tariffs on another nation if it feels that the trading partner plays unfairly.

Who pays the tariff?

A tariff is a tax on the buyer of a good, not the seller. The buyer pays the tariff when they import the good; the seller does not pay.

The picture becomes more complicated when you try to determine who ultimately pays the price of a tariff in economic terms. The importer in Country A could demand that the seller in Country B lower prices to make up for the cost of the tariff; or the importer in Country A could buy domestically, seeing an increase in the cost of goods less than the tariff. Or, depending on consumers’ willingness to pay more for a product, the cost of the tariff could be passed on in full or in part to the consumer.

At a macroeconomic level, the consumer will almost always pay more for goods under higher tariffs — though how much of the tariff they will absorb depends on many factors.

Are tariffs harmful?

One of the advantages of tariffs is that they can sometimes boost industry they were intended to protect. On the other hand, that industry’s customers can suffer.

In 2002, the U.S. imposed steel tariffs globally, with only a handful of countries being exempt (Mexico, Canada, Thailand, Argentina, and Turkey) (Source: Bloomberg,2018). President Bush implemented the tariffs in an effort to protect the domestic steel industry. The EU retaliated with a similar tariff, ultimately hurting U.S. GDP and employment, making the U.S. steel industry less competitive. The Bush steel tariffs were repealed in 2003.

When a country imposes a tariff or rate increase, a portion of it almost always gets passed down to the consumer. Tariffs can cause domestic businesses to charge higher prices for imported goods to local consumers. The company might bear some of the tariff costs, but it will usually also pass at least some of it down to consumers.

What is the US tariff rate?

Since the second world war, the US has fallen into the low tariff category, with the World Bank putting the average of tariffs on all goods at 1.61%, roughly on par with the EU and a little bit higher than Japan, which sits at 1.35%. According to the Office of the United States Trade Representative, most trade tariffs are on industrial goods (i.e., electronics), and almost 50% of goods enter the country tariff-free.

What’s the difference between a tariff and quota?

Tariffs increase the price of an import while quotas cap how much a specific business can import of a particular good. Take Canada: The Canadian government has a history of protecting its dairy industry by limiting the quantities of cheese, milk, and butter that can be imported to Canada.

What are the different types of tariffs?

Specific tariffs: This is a fixed fee levied on a unit that’s imported. The cost of this tariff varies by the imported good. A country can put a tariff of $10 on a bike, for example.

Ad valorem tariffs: A Latin term for “according to value,” ad valorem tariffs mean that a government imposes a percentage tariff on a good. For example, a country could impose a 10% tariff on all foreign cars.

What are types of non-tariff barriers to trade?

Licenses: A government can grant a license to a business to enable it to import certain goods into the country. If, for example, a government wanted to restrict the import of milk, it could grant licenses to only allow some companies to do so.

Import quotas: This restriction limits the amount of a specific item that a business can import.

Local content requirements: Much like a quota, the content requirement barrier states that the government requires a percentage of the goods imported to be domestically produced. The restriction can apply as a percentage to the value of the good or to the components of the good itself. Let’s take a car as an example. The restriction could state that 20% of the car’s components should be made domestically. It could also say that 10% of the car’s value must be domestically produced components.

Voluntary export restraints (VER): This barrier is voluntary. It goes both ways since it’s the exporting country that imposes the barrier, not the importing one. A reciprocal VER could accompany it. That means Country A could place VER on the export of cheese to Country B. In return, Country B could place a VER on the export of shoes to Country A. That increases the price of cheese and shoes, respectively, but protects domestic industries.

Who collects tariffs?

Importing companies pay tariffs to their domestic government — the government imposing the tariff. Customs and Border Protection is responsible for collecting tariffs on imported goods coming into the US.

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