What Are Tariffs?

The latest news about tariffs seems to update daily. But what does it all mean? Dr. Gordana Pesakovic, an adjunct instructor of business at Southern New Hampshire University who's taught economics and business globally over the past 25 years, explains what tariffs are, how they’ve been used throughout history, and who ultimately bears the added costs.

What Are Tariffs?

Tariffs, as a tool of trade policy, present a form of tax on goods imported from another country. Tariffs reduce imports by increasing import prices, and have an impact on government revenues and budget. Until 1913 and the introduction of the federal income tax, tariffs were the major source of government revenue in the U.S. Being a part of industrial policy, tariffs could increase production for local companies. Tariffs can also be used as a tool of foreign policy, by pressing trade partners to change, adjust, or introduce policies that are preferable for the country imposing the tariffs.

There are three basic types of tariffs.

1. “Ad valorem” tariffs are expressed in a percentage of total value.
2. Specific tariffs are imposed on the particular physical quantity of a product.
3. The compound tariff is a combination of both. It presents a certain percentage of total value. For example, 10% of the price plus a certain amount based on quantity, i.e. $1 per pound of product.

Tariffs are paid to the customs authority before the product can enter a country. In other words, they increase the price at which an imported product enters a country. This becomes additional revenue for the government of the country receiving the import. However, since there is no free lunch, the tariff on imported products is either covered by the company selling the product or is passed to consumers. Consumers end up paying more either directly by buying an imported product, or indirectly when the imported product is used to produce a final product in their country. Local producers will pass the cost of tariffs via higher prices to the final consumer.

In addition to tariffs, countries can impose non-tariff barriers. These are a set of rules and regulations that are imposed to limit imports. Examples of non-tariff barriers are quotas, embargoes, licenses and import deposits. They do not impact the price and present a source of government revenue.

The broader context of protectionist trade policy is complex and implies protection of the local producers, consumers, jobs, infant industry, national security and increasing gross domestic product. On the other hand, negative sides of protectionism could be higher prices, less competition, slower technological progress and therefore slower economic growth.

In addition, retaliation from other countries becomes imminent. Faced with the hardships of the Great Depression, U.S. import tariffs were increased to reduce imports, protect local jobs, increase production and bring the country out of a depression. However, the effects were a reduction of both imports and exports by 40% (NBER PDF Source). In addition, increased tariffs triggered retaliation measures from other countries.

Devastating consequences of World War II that followed the Great Depression brought the world to agreement to support the idea of promoting global trade by increasing interdependence between nations as a guarantor of global peace. The General Agreement of Tariffs and Trade (GATT), created in 1947 through negotiations rounds until 1993, reduced tariffs, from 22% to less than 5%.

GATT was a precursor to the World Trade Organization (WTO). The U.S. has been a WTO member since its founding in 1995 and a member of GATT since 1948.

Joe Cote is a writer and organic marketer at Southern New Hampshire University (SNHU), where he has worked since 2016. Previously he spent more than a dozen years as a reporter and editor at weekly and daily newspapers in Vermont and New Hampshire. He lives near SNHU's Manchester, New Hampshire campus with his wife and daughter. Connect with him on LinkedIn.