What are Tariffs: How They Work, and Their Impact

what are tariffs Ai generated image of shipping yard
what are tariffs Ai generated image of shipping yard
Ai generated image of shipping yard

Tariffs are one of the most commonly used tools in global trade, yet they remain a topic of confusion for many. Whether you’re a consumer, business owner, or policymaker, tariffs can have significant effects on the prices of goods, international trade relationships, and economic policy.

In this article, we’ll explore what tariffs are, how they work, and who gets affected by them, while breaking down their pros and cons.


What Are Tariffs?

A tariff is a tax or duty imposed by a government on imported or exported goods. Tariffs are typically applied as a percentage of the value of the goods being traded. For example, if a country sets a 10% tariff on imported cars, the importer must pay 10% of the car’s value as a tax to the government.

Tariffs serve several purposes, including:

  • Generating revenue for the government.
  • Protecting domestic industries from foreign competition.
  • Leveraging trade negotiations between countries.

There are two main types of tariffs:

  1. Ad Valorem Tariffs: Charged as a percentage of the total value of the product.
  2. Specific Tariffs: Charged as a fixed fee per unit, regardless of the product’s value (e.g., $5 per pair of shoes).

How Do Tariffs Work?

When a tariff is imposed, the following process typically occurs:

  1. The Importer Pays the Tariff: The company or entity bringing goods into the country pays the tariff to customs authorities.
  2. Increased Costs Are Passed to Consumers: To offset the added cost, importers often raise the price of the goods, which affects consumers.
  3. Government Collects Revenue: The tariff payments go to the government, generating income.

For example, if a company imports $1 million worth of steel and there’s a 25% tariff, the importer must pay $250,000 in tariffs to the government. This added cost may result in higher prices for the end consumer, such as in cars or construction materials.

How Tariffs Calculated: Some Examples

When a tariff is applied to an imported product, such as cars, the percentage tariff (e.g., 10%) is typically calculated based on the imported value of the goods, which is commonly referred to as the Customs Value or Declared Value. Let’s break this down to clarify what this means and how it works in practice.

What Is the Customs Value?

The Customs Value is the amount used by a country’s customs authority to determine the tariff owed. It is usually based on the transaction value, which is the price paid or payable by the importer to the exporter for the goods. In simpler terms, it’s typically the wholesale cost—the price the importer pays to the manufacturer or exporter to acquire the goods before any retail markup.


Factors That Affect the Customs Value

The Customs Value often includes more than just the base price of the product. Additional costs can be factored in depending on the importing country’s rules, such as:

  1. Freight (Shipping Costs): The cost of transporting the goods to the destination country.
  2. Insurance: The cost of insuring the goods during transit.
  3. Other Adjustments: Certain countries may require the inclusion of royalties, licensing fees, or other charges related to the product.

For example, if an importer pays $20,000 for a car, and an additional $2,000 for shipping and insurance, the total customs value would be $22,000. A 10% tariff would then apply to this amount, resulting in a tariff payment of $2,200.


What It Does Not Include

  1. Retail Value: Tariffs are not calculated based on the car’s final retail price (what the consumer pays at a dealership).
  2. Cost of Production: The cost to manufacture the car (labor, materials, etc.) is also not directly used unless it’s reflected in the transaction value.

Examples of How Tariffs Are Applied

Scenario 1: Wholesale Price

  • A dealership imports a car from another country for $30,000 (the transaction value).
  • The shipping and insurance add $3,000.
  • The total customs value is $33,000.
  • A 10% tariff means the importer pays $3,300 in tariffs to the government.

Scenario 2: Increased Costs for Consumers

  • The dealership must cover the cost of the $3,300 tariff.
  • To maintain profitability, they increase the car’s retail price, passing the cost onto the consumer.
  • This means the consumer pays more for the car at the dealership.

Why Is It Based on Wholesale Value?

Governments calculate tariffs on the wholesale value (or transaction value) rather than the retail price to ensure consistency. Retail prices can vary widely between markets due to local taxes, operating costs, and profit margins, whereas wholesale prices are more standardized.

By focusing on the customs value, tariffs are calculated in a way that aligns with international trade practices and provides a predictable structure for importers and governments alike.


man shopping for produce ai generated image
man shopping for produce ai generated image

How Tariffs Affect Consumers

When a tariff is imposed, the costs are often passed down the supply chain, eventually reaching the consumer. This means the retail price of goods increases, making everyday items more expensive. While tariffs are aimed at protecting domestic industries or generating government revenue, they can inadvertently burden consumers, especially for imported goods that lack domestic alternatives.

How Tariffs Impact Retail Prices

When an importer pays a tariff, they typically raise the price of the imported product to recover their costs. For example:

  • If a car’s wholesale value is $30,000 and the importer pays a 10% tariff ($3,000), that $3,000 is added to the cost.
  • Retailers further mark up the price to maintain their profit margins, resulting in a higher final cost for consumers.

The extent of the price increase depends on several factors, such as competition, demand elasticity, and whether alternative domestic products are available.


Historical Examples of Tariff Impacts on Consumers

1. Smoot-Hawley Tariff Act (1930)

  • The Smoot-Hawley Tariff Act increased tariffs on over 20,000 imported goods in an effort to protect U.S. farmers and manufacturers during the Great Depression.
  • Impact on Consumers: The higher tariffs led to increased prices for everyday items such as sugar, textiles, and shoes, putting additional strain on American families already struggling economically.
  • Economic Consequences: Other countries retaliated with their own tariffs, leading to a trade war that exacerbated the global economic downturn.

2. U.S.-China Trade War (2018–Present)

  • The U.S. imposed tariffs ranging from 10% to 25% on $550 billion worth of Chinese goods, including electronics, clothing, and household items.
  • Impact on Consumers:
  • Prices for items such as washing machines increased by an estimated 12% after tariffs were imposed.
  • A study by the Federal Reserve estimated that the average American household incurred an extra $1,277 per year in costs due to the tariffs.
  • Broader Effects: Companies like Apple passed some of these costs onto consumers, increasing the prices of products such as iPhones and MacBooks.

3. EU Retaliatory Tariffs on U.S. Goods (2018)

  • In response to U.S. tariffs on steel and aluminum, the European Union imposed tariffs on American products, including bourbon, motorcycles, and orange juice.
  • Impact on Consumers:
  • Harley-Davidson motorcycles, subject to a 25% EU tariff, saw price increases of several thousand dollars for European buyers.
  • American whiskey exports to Europe declined by 37%, reducing market availability and increasing prices.

Percentage Changes in Consumer Costs

Tariffs can lead to significant price increases, depending on the tariff rate and the product category. For example:

  • Steel and Aluminum Tariffs (2018): U.S. tariffs of 25% on steel and 10% on aluminum led to a 16% increase in steel prices and a 9% increase in aluminum prices. These increases trickled down to products like cars, construction materials, and canned goods.
  • Washing Machine Tariffs (2018): A 20% tariff on imported washing machines resulted in a 12% rise in consumer prices, according to studies by the University of Chicago.

Long-Term Impacts on Consumers

While some consumers may adapt by seeking out domestic alternatives, tariffs can still lead to:

  • Reduced Choice: Limited access to affordable imports may result in fewer product options.
  • Higher Inflation: As tariffs increase costs for importers and producers, the overall price level of goods in the economy can rise, contributing to inflation.
  • Economic Inequality: Tariffs disproportionately affect low-income households, which spend a larger percentage of their income on essentials like food, clothing, and appliances.

Balancing Protection and Cost

While tariffs are intended to protect domestic industries, the higher costs often leave consumers bearing the brunt of the policy. Historical examples illustrate that while tariffs may serve short-term political or economic goals, their long-term effects can weigh heavily on household budgets and economic growth. For consumers, the key is to understand how tariffs influence the cost of goods and adjust purchasing habits accordingly.


List Those Affected by Tariffs

1. Consumers

Consumers often feel the impact of tariffs in the form of higher prices for goods, especially those that are imported. For example:

  • Electronics, clothing, and cars may become more expensive if tariffs are placed on their components or final products.
  • Tariffs on raw materials like steel or aluminum can also increase the cost of domestic goods that rely on these imports.

2. Domestic Businesses

  • Manufacturers: Tariffs can benefit domestic manufacturers by reducing competition from cheaper foreign goods, potentially increasing sales for local companies.
  • Import-Dependent Businesses: Companies that rely on imported goods or materials may see their costs rise, forcing them to increase prices on consumers or absorb the additional expenses.

3. Foreign Exporters

Tariffs make foreign goods more expensive in the importing country, often leading to reduced demand. Exporters in countries subject to tariffs may lose market share to domestic competitors or exporters from countries with no tariffs.

4. Governments

Governments collect revenue from tariffs, which can be used to fund public projects or offset budget deficits. However, high tariffs can also strain international trade relations, leading to retaliatory tariffs.


two chess pieces on a world map ai generated image
two chess pieces on a world map ai generated image

Why Are Tariffs Used?

1. To Protect Domestic Industries

Tariffs can shield local industries from foreign competition by making imported goods more expensive. For example, a country may impose tariffs on agricultural imports to protect its farmers.

2. To Generate Revenue

In some countries, tariffs are an important source of government income, particularly in developing nations with limited tax collection infrastructure.

3. To Influence Trade Policy

Governments may use tariffs as leverage in trade negotiations, encouraging other countries to lower their trade barriers or adjust policies.

4. To Punish or Pressure Other Countries

Tariffs can be imposed as a political tool to penalize countries for certain actions, such as unfair trade practices, currency manipulation, or human rights violations.


man in shipping yard Ai generated image
man in shipping yard Ai generated image

Pros and Cons of Tariffs

Pros

  • If Applied Correctly Could Protect Local Jobs: By limiting competition from foreign goods, tariffs can help preserve jobs in domestic industries.
  • Encourages Domestic Production: Higher prices for imported goods may incentivize consumers and businesses to buy locally.
  • Generates Government Revenue: Tariffs provide a direct source of income for governments.

Cons

  • Higher Costs for Consumers: Tariffs often lead to increased prices for everyday goods and services for everyone. This includes both the country imposing the tariff and the company required to pay it.
  • Trade Wars: Retaliatory tariffs between countries can escalate into trade wars, harming global trade and economic growth. Nobody wins in this scenerio.
  • Economic Inefficiencies: Tariffs can distort markets, leading to reduced competition and inefficiencies in production.
  • Impact on Global Relations: Excessive tariffs can strain diplomatic and trade relationships between countries, especially when they are used as a tool for retaliation or as a means of coercion.

Examples of Tariffs in Action

The U.S.-China Trade War

Starting in 2018, the United States imposed tariffs on hundreds of billions of dollars’ worth of Chinese goods, citing unfair trade practices and intellectual property theft. China retaliated with its own tariffs on U.S. goods. The trade war resulted in higher costs for businesses and consumers in both countries and disrupted global supply chains.

European Union Tariffs on U.S. Goods

In response to U.S. tariffs on steel and aluminum, the European Union imposed tariffs on American products like motorcycles, bourbon, and orange juice. These tariffs aimed to pressure the U.S. government to reconsider its trade policies.


How Tariffs Affect Global Trade

Tariffs can have far-reaching consequences for international trade. They often lead to:

  • Supply Chain Disruptions: Tariffs can force companies to rethink their supply chains, sourcing goods from countries without tariffs or reshoring production.
  • Retaliatory Measures: Countries may impose counter-tariffs, creating a cycle of escalating trade barriers.
  • Shift in Trade Relationships: Businesses may shift trade to countries with more favorable trade agreements, altering global trade patterns.

The Future of Tariffs

As globalization continues, the role of tariffs in shaping trade policy remains a contentious topic. While they can protect local industries and generate revenue, their long-term impact on consumers, businesses, and global relations must be carefully considered. Governments and policymakers must weigh the benefits of tariffs against their potential to disrupt economies and harm international partnerships.


By understanding tariffs, their mechanisms, and their implications, consumers and businesses can better navigate the complexities of global trade and make informed decisions in an interconnected world.