A tariff is a charge levied on imported goods. Customs authorities impose tariffs on goods arriving at a nation’s borders. Countries can sign free trade agreements to reduce or eliminate them.
Tariffs can also apply to exported goods, but this is rare. This article will focus on tariffs on imports, which is how the word “tariff” is generally applied.
Tariffs are currently a popular topic in the news. When US President Trump speaks of a “trade war” with China, tariffs are the weapon of choice. The current US administration is also turning away from several existing and proposed trade agreements.
Tariffs affect businesses of all sizes. With appropriate planning, some business owners can mitigate the impact of tariffs. Certain businesses can also benefit from them. But tariffs often hit small businesses the hardest.
What Are Tariffs?
When a person or business imports a product or material, customs authorities can require them to pay a charge. This charge is the tariff.
There are many reasons why a person or business may wish to import goods or materials from overseas. Compared to domestic goods, imported goods might be:
- Better quality
- Unavailable domestically
While importing goods can be beneficial for businesses and consumers, there are many reasons why national governments may wish to discourage imports. We’ll look at these below.
Who Pays a Tariff, and Who Gets the Money?
The burden of paying a tariff falls on the business or person importing the goods. They pay the money to a customs authority (e.g., Customs and Border Protection). The customs authority then passes the money onto the treasury, or a specific government department (e.g., the Department of Commerce).
Customs authorities typically require importing businesses to calculate the tariffs owed on the imported goods themselves. Once the goods have passed through customs, the importer must pay within a certain period of time. Failure to pay a tariff can result in penalties or legal action.
There are indirect costs for other parties too. For example, an importer might pass the cost of tariffs onto their suppliers by only agreeing to pay a lower rate for the goods. The cost of tariffs can also be passed onto consumers or other businesses if the importer charges a higher price for the goods.
Why Do Countries Impose Tariffs?
Tariffs primarily exist to make imported goods less attractive. If the price of imported goods rises, buying or selling domestically-produced goods might be a more attractive option. They might also serve to keep certain products out of the country altogether.
There are many reasons a government may wish to discourage imports:
- In an attempt to decrease unemployment
- To raise revenues for the state
- To ensure strategically important industries can survive
What Are Some Different Types of Tariff?
A tariff can take several forms:
- Ad valorem tariff – a tariff calculated as a proportion of the price of the goods being imported. For example, if all computers imported into a country are subject to a 10 percent ad valorem tariff, a computer that costs $100 will incur a tariff of $10.
- Specific tariff – a tariff imposed as a cost per unit (or according to weight or volume). For example, a specific tariff on the import of computers might be the same amount regardless of the type of computer costs the importer $100 or $1000.
- Compound tariff – a combination of ad valorem and specific tariff – a charge per unit, plus a charge as a proportion of the price.
Tariffs can also be categorized according to the purpose for which they are imposed:
- Revenue tariff – principally aimed at raising money for the importing country’s treasury.
- Protective tariff – principally aimed at supporting domestic businesses or damaging a foreign nation’s economy.
What Is the Difference Between a Tariff and a Tax?
Tariffs are sometimes described as a tax. They represent an involuntary charge levied by governments. So in this sense, tariffs are a type of tax.
What are the Risks of Tariffs?
There are several risks involved when a government imposes tariffs:
- Tariffs can harm businesses that import goods.
- Tariffs can cause diplomatic issues with other countries.
- Other countries can impose retaliatory tariffs, which hurt exporters.
Generally, economists broadly disapprove of tariffs. In 2018, a forum of ten economists unanimously agreed that the new aluminum and steel tariffs imposed by the US would not improve the country’s overall welfare.
How Do Tariffs Affect Businesses?
Tariffs have different effects on different types of businesses and people.
Here are some ways that tariffs affect different types of businesses and people, from the perspective of the country imposing import tariffs.
How Do Tariffs Affect Small Businesses?
Tariffs can hurt small businesses.
When tariffs go up, this can often be more damaging to small businesses than large ones, because:
- Small businesses have smaller margins and are less able to absorb additional costs
- Small businesses have less leverage with suppliers and are less able to force them to reduce their prices to compensate for tariffs
- Small businesses have fewer resources to dedicate to finding new suppliers
However, just as certain large businesses will benefit from the imposition of tariffs, some small businesses will benefit from tariffs too.
How do Tariffs Affect Manufacturers?
Tariffs can benefit domestic manufacturers. Tariffs raise prices on imported goods. Domestic manufacturers can gain a comparative advantage from this.
Let’s say a US clothing manufacturer makes jeans at a cost price of $10 per pair, and a Chinese clothing manufacturer makes jeans at a cost price of $8.50 per pair. A US clothing retailer is incentivized to purchase jeans from the Chinese company, even with a 10 percent tariff that raises the price to $9.35.
Raise tariffs on imported clothing to 25 percent, and suddenly the Chinese jeans cost $10.63. The US clothing retailer is thus incentivized to purchase jeans from the US clothing manufacturer.
Tariffs can hurt domestic manufacturers who source materials from abroad. Manufacturers sometimes need to source parts and materials from abroad. If a domestic manufacturer finds a cheap overseas supplier for a particular component, this can significantly reduce its production costs. Put a tariff on imports of this component, and production costs will rise.
In some situations, this could result in domestic manufacturers being unable to compete with foreign manufacturers. If there’s a tariff on imports of leather, but not shoes, domestic shoemakers will be hurt by this.
Tariffs can also hurt domestic manufacturers who export goods. If the US places tariffs on imports of goods that are typically imported from China, China will retaliate by imposing tariffs goods that are typically imported from the US. US exporters will, therefore, represent a less attractive option for Chinese importers.
How Do Tariffs Affect Retailers?
Tariffs typically hurt domestic retailers. Consider the example above, with the US clothing retailer changing its supplier to a US manufacturer. This will cut into the retailer’s profits one way or another. Either it absorbs the costs of tariffs or passes them onto its customers.
How Do Tariffs Affect Businesses in New Industries?
Tariffs can benefit some domestic companies operating in new industries.
Governments will also sometimes impose tariffs on specific types of imports to stimulate activity among emerging industries.
For example, a company that is developing cutting edge technology might be unable to compete with cheaper imports from overseas. The government might feel that the country would benefit if this domestic industry was given a chance to develop.
Companies operating in new industries that have not been targeted in this way will face the same harms and benefits as companies in other industries.
How Do Tariffs Affect Consumers?
Tariffs typically hurt domestic consumers (short term). Tariffs can impose costs on domestic retailers. They may need to (or choose to) pass these costs onto their customers.
If a US retailer once paid $110 for imported TVs and, due to tariffs, they must now pay $125, it may be able to absorb this extra cost. Or, it may seek to recover this cost from its customers.
Tariffs can benefit domestic consumers (long term)
Of course, the idea behind certain tariffs is that they benefit society more broadly. If so, consumers can ultimately derive some benefit from the imposition of tariffs.
Also, the purpose of certain tariffs is to keep unsafe or low-quality goods out of the domestic market. Consumers can benefit from this protection.
How Do Tariffs Affect Workers?
Tariffs can benefit domestic workers. Overseas companies are often able to offer cheaper goods because they pay their workers comparatively low wages.
A domestic company might see little reason to keep manufacturing goods at home if they have to pay a hefty wage bill. Without tariffs, the company could save money by either moving the factory overseas or finding an international supplier.
Let’s say a US computer manufacturer produces some of its parts in US factories. If the US signs a free trade agreement with Indonesia, imports from Indonesia will go down in price. It may be more cost-effective to close the US factories and import the parts from Indonesia instead. This means US workers lose their jobs.
Tariffs can harm domestic workers. Of course, if a business is hurt by tariffs, its employees will feel the pain too. Therefore, imposing tariffs can backfire – or hurt some employees while benefiting others.
How Do Tariffs Affect Businesses in Strategic Industries
Tariffs can benefit businesses involved in producing strategically important goods and materials.
No country is entirely self-sufficient. It’s not a big deal for one country to be dependent on another for bananas or mangoes. But when it comes to steel other strategically important materials, some nations feel that they need their own supply.
Cheap steel imports can soon lead to a country’s steel plants closing. This can make it difficult to ramp up production of weapons at times of war.
Therefore, tariffs are often imposed on strategically important materials. This forces businesses to buy steel domestically, thus supporting the nation’s steel industry and keeping the country war-ready.
How Are Tariffs Affected By Politics?
Some governments reject tariffs, believing that free trade between nations is a positive thing – even if it means some domestic businesses are priced out of domestic markets.
Other governments see tariffs as an important means by which to achieve their political agenda and exert their influence on the international stage.
What are Protective Tariffs?
Protective tariffs are part of a protectionist agenda. Protectionism means structuring the economy in such a way as to protect domestic industries at the expense of foreign industries.
Protective tariffs are often as much about damaging another nation’s economy as protecting one’s own. A government might see its citizens contributing billions of dollars in trade revenue by purchasing goods from a hostile or powerful foreign country. Protective tariffs can prevent this.
Are the US and China in a Trade War?
The term “trade war” is quite provocative. But it’s reasonable to say that the US and China have been in a trade war since 2018.
Both nations are imposing steep tariffs on each others’ goods, and the situation doesn’t look like it will be resolved any time soon. The markets of the US and China are deeply intertwined, and even a small rise in tariffs on either side can have a big impact on businesses.
Is the US in a Trade War with Any Other Countries?
The term “trade war” is generally used to describe the situation between the US and China. But this isn’t the only trade relationship involving tariffs.
The US also raised tariffs on imports of steel and aluminum in 2018, upsetting Canada and Mexico. However, these tariffs were dropped in May 2019.
Trump has also demonstrated an aversion to certain free trade agreements, such as the North American Free Trade Agreement (NAFTA), and the proposed Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP).
Whatever emerges from the ashes of these treaties is unlikely to involve a reduction in tariffs. Businesses must plan accordingly.
Tariffs affect everyone. An increase in tariffs directly increases a company’s spendings and decreases profits. Many businesses thus increase their product prices as companies are not left with many alternatives to increase gross profit margin. This phenomenon, however, is something that could be detrimental for a company as consumers steer away from high prices. Tariffs are government-controlled, and thus out of the control of companies and businesses that are being affected. If you want to remain at the very top of the competitive market, you will typically want to maintain your current product prices. But how do you do this while maintaining and increasing your gross profit margin?
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