Government bodies can use tariffs to bolster domestic industries and achieve foreign trade and policy objectives. Read on to learn more about tariffs, the different ways these taxes can be applied, and the roles they can play in international economics and diplomatic relations.
What are tariffs?
What are tariffs?
Tariffs are a form of tax imposed by national or supranational government bodies on the import or export of goods. Tariffs are also sometimes referred to as duties.
Why are tariffs important?
Why are tariffs important?
Beyond just being a source of tax revenue, tariffs are a way that governments can modify trade incentives. In particular, tariffs can be important in protecting domestic industries and economic interests.
Tariffs can be a form of economic protectionism, but the costs typically wind up being passed on to domestic shoppers through price hikes on consumer goods. Higher prices on imported goods may give domestically produced goods a competitive advantage, but governments try to strike a balanced approach to tariff policy that works for the good of the broader economy.
How do tariffs work?
How do tariffs work?
Tariffs are collected when goods exit the domestic area and cross into foreign borders. Import tariffs are far more common than export tariffs. When pursuing growth opportunities in international markets, businesses must be mindful of how tariffs could affect the market for their products and their pricing strategies.
Different categories of products typically have different levels of tariffs applied. For example, vegetables, auto parts, and dairy products have relatively high import tariffs in the U.S., and tariffs on sneakers and tobacco are even higher. On the other hand, not all goods are subject to import duties.
Governments will also set tariff levels on a country-by-country basis. In general, countries with less-developed economies tend to have higher tariffs.
Academic views on tariffs
Academic views on tariffs
Ryan Monarch, PhD
The Motley Fool: What are the short and long-term economic effects of tariffs that matter most to investors?
Ryan Monarch: “In the short-run, tariffs are seen as inflationary, and all else equal, the more widespread the tariffs, the tighter Federal Reserve policy will likely be in order to tamp down upward price pressure. The exchange rate is also likely to appreciate – as U.S. interest rate policy remains tight relative that of other countries, the dollar is likely to strengthen. The short run is also characterized by significant uncertainty about what trade policy will look like, leading to the pulling back of investment and production for many companies.
In the long-run, inflation expectations may become less stable, and as consumers come to expect inflation, this itself can lead the Federal Reserve to take stronger tightening actions. If a global trade war truly breaks out, in which countries continue to escalate tariffs and other actions against each other, the economic consequences for all sides would be dire, and could lead to a major downturn in global growth.”
The Motley Fool: How do tariffs impact the economy?
Ryan Monarch: “A tariff is a tax on an imported good paid by an importer in order to obtain their purchase after passing through customs. The basic purpose of a tariff is to increase the price of imported goods from a particular country in order to protect domestic producers of that good.
Since tariffs increase the price of imported goods, tariffs impact the economy in a number of ways. First, average import prices increase as the scope of imported products facing tariffs expands. Second, tariffs tend to lead the imports of the affected goods to decrease. In some cases, affected businesses may substitute to purchasing products from other source countries or domestic alternatives, though the availability of such alternatives varies greatly depending on the imported product. Third, increase in import prices lead to higher costs for businesses using tariffed products as inputs, and affected firms tend to reduce employment, investment, and production in response. In fact, research on the 2018-2019 trade war has shown that job losses at U.S. firms using tariffed inputs well-exceeded job gains in protected sectors, and U.S. exports weakened as a result of higher import tariffs. Finally, government revenue increases as a result of the tax being applied to importers, though tariff revenue is a small fraction of overall government revenue in the United States.”
The Motley Fool: Do tariffs cause inflation?
Ryan Monarch: “Tariffs cause the price of affected goods to rise. In fact, research into the 2018-2019 trade war has shown that the prices of U.S. imported goods affected by tariffs rose by nearly the entire amount of tariffs imposed, meaning that U.S. importers bore the brunt of the increase in costs. Additionally, if importers substitute toward alternatives that are more expensive than their original suppliers, this can also cause prices to rise.
The extent to which this causes inflation depends on many factors. One consideration is the scope of the tariffs: The more widespread tariffs are, the greater the inflationary pressures will be. It also depends on how importers respond to higher costs: In 2018-2019, many U.S. importers did not pass on the full amount of their cost increase to their consumers, and increases in consumer prices are the traditional metric of inflation. In addition, movements in exchange rates can counteract direct increases in import prices. For example, the dollar typically strengthens after tariffs are imposed, making imports cheaper. Central banks might also respond to widespread tariffs with tighter interest rate policies, also tamping down inflationary pressures. The exact measure of inflation along with the path of tariff increases also matters, as a one-off increase in prices due to tariffs would disappear quickly from short-run measures of inflation. All told, tariffs lead to higher prices, but there are numerous possibilities for how exactly these higher prices may be reflected in overall consumer price inflation.”
Jason Miller, PhD
The Motley Fool: Who pays for tariffs imposed on U.S. imports?
Jason Miller, PhD: “The importing entity pays the tariffs.”
The Motley Fool: Does the U.S. benefit from tariffs on Mexico and Canada?
Jason Miller, PhD: “The U.S. certainly does not economically benefit from tariffs, as tariffs will increase costs (thus contributing to inflation) and disrupt production networks. Prior research documents that U.S. manufacturers that export who saw larger increases in tariffs for the goods they imported from China saw reduced exports in 2019; we would expect the same mechanism to work regarding Canada and Mexico.”
The Motley Fool: Do tariffs have any impact on prices of domestically produced goods?
Jason Miller, PhD: “Yes, especially in the case of metals such as steel and aluminum, domestic producers will increase their prices when foreign goods are subject to more tariffs. We saw this play out in 2018, as steel prices rose sharply that year, roughly 20%.”
David Ortega, PhD
The Motley Fool: How will tariffs impact the U.S. economy?
David Ortega, PhD: “Tariffs function as taxes on imported goods, leading to increased costs for U.S. importers. These heightened costs often translate to higher prices for consumers and businesses relying on these imports to produce goods domestically."
The Motley Fool: Who pays for tariffs imposed on U.S. imports?
David Ortega, PhD: “Importers pay the tariff, which raises their costs, and this gets passed down in the form of higher prices.”
The Motley Fool: Which products are going to cost more due to tariffs?
David Ortega, PhD: "Tariffs will increase the price of food, especially for items that we rely on our trading partners like produce. At the grocery store, the impact will be felt more immediately on perishable products that we import. Food products like avocados, tomatoes, peppers, berries, cucumbers, etc. — these are products that have a relatively short shelf-life and for which we can’t hold inventory for a prolonged period. Other food and beverage products like imported Mexican beer, tequila, Canadian maple syrup to name a few are likely to see prices increase when tariffs are imposed.”
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Example
An example of tariffs in action
Depending on their scope and application, tariffs can be a source of tension between governments. If one country implements or raises tariffs on another country's goods, there's a risk that the second country will respond in kind.
In recent years, the U.S. and China have increased tariffs imposed on each other's products. The U.S. began raising tariffs in 2018 under President Donald Trump, notably implementing a 25% tariff on steel imported from China and raising duties on other materials and products. In turn, China implemented its own tariff hikes on a wide range of goods. The trade squabble between the two countries escalated quickly.
Although a subsequent trade deal helped reduce tensions to an extent, many of the tariffs implemented at the beginning of the trade dispute remain in place. Despite increasingly adversarial relations, trade between the U.S. and China has continued to reach new highs.
