Everything You Need to Know to Understand Tariffs

They’ve been around for a long time, and they’re having another moment. Here’s what you need to know.

Everything You Need to Know to Understand Tariffs

It’s all over the news. The U.S. has imposed new tariffs. Depending on who you listen to, that could be just the boost the country’s economy needs, or it could rain down gloom and destruction on the American people. These tariffs, naturally, have their own Wikipedia page.

Meanwhile, you might be thinking, “What exactly are tariffs and what do they actually do?”

Here are the basics you need to know.

What Are Tariffs?

The Merriam-Webster dictionary definition: Tariffs are “a schedule of duties imposed by a government on imported or in some countries exported goods.”

Simply put, tariffs are taxes added to (usually) imported goods. You may also hear them called import duties, import fees or customs.

For example, on September 1, 2019, a new 15 percent tariff on some clothing, shoes and sporting goods coming to the United States from China took effect.

Why Do Governments Impose Tariffs?

It raises money for the government, of course.

It also exerts pressure on companies to move their supply partnerships away from the country that’s being targeted. Domestic companies can also benefit. Since their international competitors’ products are now priced higher, they can also boost their prices in the less-competitive local market.

Who Pays the Money?

In the United States, the tariffs are paid by the U.S. companies and entities that import products to the country. It’s the same in other countries, too: The companies and entities that import products pay the tariff.

The tariffs are paid by the country that imposes them.

Who Really Pays the Money?

The costs of tariffs in a country are generally passed along to consumers within that country. The costs tend to hit lower-income households disproportionately. According to the Peterson Institute for International Economics, households with income under $40,000 will experience a much greater financial impact than those above that income level.

Who Gets the Money?

In the United States, companies and entities pay the money to U.S. Customs. It’s the same in other countries: The companies and entities that import products pay into their own country’s coffers.

How Tariffs Work, Part One

Why impose tariffs? The concept hasn’t changed a whole lot since 1789. The idea behind slapping tariffs on imported goods is two-fold. The government raises money without directly taxing its own people.

How Tariffs Work, Part Two

Secondly, by adding tariffs to imported goods, the consumer costs of those goods increases. Consequently, domestic manufacturers can have a competitive edge and sell more of their own products.

Of course, if your family wants to buy an imported product (and guess what, a LOT of products are imported), you’re effectively paying the tariff.

Ad Valorem Tariffs

There are two main types of tariffs. The first type of tariff is called ad valorem. “Ad valorem” is Latin for “to value.”

Ad valorem tariffs work by imposing a tariff that’s based on a fixed percentage of the value of the product. If the international value of the product rises or drops, the tariff will follow suit. These are the most common kind of tariffs.

Ad Valorem Example

One of the big moves in the U.S. president’s arsenal was to impose a 25 percent ad valorem tax on imported steel.

So, if the current cost of steel is $.02 per pound (it’s much higher, but we’ll use this number for ease of calculation and understanding), the flat cost of importing 25,000,000 pounds of steel would be $500,000. The tax levied on that amount at 25 percent would be $125,000.

If steel goes up to $.04 per pound, that same 25 million pounds would cost $1 million, with an added tax of $250,000.

Specific Tariffs

Specific tariffs are another kind of tariff that’s simpler to figure out. Instead of using percentages and fluctuating costs of goods, a specific tariff simply puts a flat tax amount on items.

Specific Tariff Example

Let’s say the United States imports hats from France. A specific tariff would impose a set amount, say $.13 per hat imported.

The math is easy on this one. If you import 1 million hats, you pay $130,000 in tariffs. If the value of those hats goes up or down on the market, it has no effect on the tariff.

The Effects of Tariffs

The reason that tariffs are big news is that any newly imposed tax on imported goods has a number of trickle-down effects:

Increased revenue for the government
Increased prices on the imported goods for the consumer
Fewer goods coming in
A possible shift in supply and demand, causing issues for the producing country
Retaliatory tariffs imposed on goods by the affected country

The Case for Increased Tariffs

Those who are in favor of increasing tariffs see it as a way to give domestic producers a leg up in the competitive market. If foreign goods cost more, they believe people will buy more domestic products. As a result, domestic manufacturers will need to make more, which means more jobs for domestic workers.

The Case Against Tariffs

Those opposed to high tariffs as a means to increase domestic production see it as a “rob Peter to pay Paul” scenario.

For instance, the U.S.’s imposed tariffs on steel and aluminum may well increase domestic sales and production in those industries. More jobs? Probably.

However, as a result of those tariffs, India has slapped retaliatory tariffs on U.S. apples and almonds. As the United States’ No. 1 trade partner for almonds and No. 2 importer of apples, these tariffs will have a significant effect on those industries in the U.S. Fewer jobs? Probably.

The European Union has imposed new tariffs on 180 different products in response to the President’s actions.

Many economists view tariffs as destructive. As the Economist writes, “Tariffs impose costs on the country setting them. They invite foreigners to respond with retaliatory ones of their own, hurting exporters. (When new tariffs break past promises, they also erode trust.) Moreover, tariffs distort the economy, reducing productivity.”

Why Should We Care About Tariffs?

Because tariffs have a very direct and very significant effect on the economy. They serve a purpose and no economists are calling for them to go away. However, if any one country or union decides to increase tariffs too much, it can create a worldwide economic showdown, or even a crisis.

Competition or Cooperation?

In a best-case scenario, tariffs between two countries serve a mutually beneficial purpose. Each country wants to keep the price of foreign goods higher than the cost of domestic goods as a rule. But, by keeping import duties reasonable, that country encourages their trade partner to do business with them and import some of their own goods and also stick to reasonable tariff rates.

When Tariffs Trigger a Trade War

When it becomes a competition, you have what is called a trade war. Each country tries to get the upper hand by imposing tariffs that will cripple the other country’s bargaining power. Trade wars can be damaging to the economies of the two countries involved, as well as the world market.

Take soybeans, for instance. As Reuters reports, the trade war between the U.S. and China has greatly affected farmers in the U.S. “For North Dakota, losing China — the buyer of about 70% of the state’s soybeans — has destroyed a staple source of income,” writes Karl Plume. The U.S. government, in turn, has attempted to support farmers that have lost markets with subsidies.

The Silver Lining

The silver lining on tariffs, if you are looking for it, is that most of your favorite products won’t be going away. They may be more expensive and harder to find, but they should still be on the market.

The History of Tariffs in the United States

Tariffs have been around longer than the United States. Even before the U.S. won its freedom, the colonies imposed duties on goods coming in from other countries.

During the American Revolutionary War, trade with Britain stopped, so many colonies shifted their trade to each other they imposed new tariffs on goods coming in from other colonies.

When the United States Constitution took effect, it banned the colonies from imposing duties on goods passing between them.

The Tariff of 1789

One of the first actions taken by the new government of the United States was to impose tariffs on imported goods. This is referred to as the Tariff of 1789.

The fledgling regime needed funds, and by adding taxes to goods coming in from other countries, it could raise money without directly taxing its own people.

The new tariffs were also imposed to raise the cost of imported goods, making the market more favorable for domestic producers and manufacturers.

The Smoot-Hawley Tariff

As the Great Depression hit the United States, the government sought to boost the economy by raising tariffs on foreign agricultural products. The intent was to protect domestic farmers from foreign competition.

A petition was raised and signed by over 1,000 economists urging the president not to impose the tariffs. However, the Smoot-Hawley Tariff Act of 1930 was signed into effect by President Herbert Hoover.

As a result of the new tariffs, U.S. trade partners also issued new duties on American goods sold abroad. The cumulative effect was to worsen the economy, making the Great Depression worse.

Will It Work This Time?

Hard to know. The hope is that tariffs will change trade dynamics and might become a negotiating lever. So far, news reports suggest consumers in the U.S. and abroad are being hurt by tariffs.