How do tariffs work

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Measure content performance. Develop and improve products. List of Partners vendors. World Economy Trade Policy. Table of Contents Expand. Table of Contents. What Are Tariffs? How Do Tariffs Work? Pros and Cons. Examples of U. By Kimberly Amadeo. Learn about our editorial policies. Reviewed by Michael J Boyle. Article Reviewed February 23, Michael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics.

Learn about our Financial Review Board. Pros Threatened domestic industries may ask for tariffs Can create more domestic jobs in certain industries. Cons Consumers pay higher prices Hurts relationship with other countries. Key Takeaways Tariffs are taxes paid by consumers of imported goods, raising the prices of goods brought in from another country. Tariffs are often effectively protectionist barriers—increasing the price of foreign products that compete with domestically produced ones.

Although tariffs aim to protect local industries, it may hurt the economy as a whole, especially if countries retaliate with their own tariffs. Tariffs cannot exist in free trade agreements.

Article Sources. Your Privacy Rights. Tariffs are paid to the customs authority of the country imposing the tariff. Tariffs on imports coming into the United States, for example, are collected by Customs and Border Protection, acting on behalf of the Commerce Department.

It is important to recognize that the taxes owed on imports are paid by domestic consumers and not imposed directly on the foreign country's exports. Often, goods from abroad are cheaper because they offer cheaper capital or labor costs; if those goods become more expensive, then consumers will choose the relatively costlier domestic product.

Overall, consumers tend to lose out with tariffs, where the taxes are collected domestically. Tariffs are often created to protect infant industries and developing economies but are also used by more advanced economies with developed industries. The levying of tariffs is often highly politicized. The possibility of increased competition from imported goods can threaten domestic industries.

These domestic companies may fire workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. The unemployment argument often shifts to domestic industries complaining about cheap foreign labor, and how poor working conditions and lack of regulation allow foreign companies to produce goods more cheaply.

In economics, however, countries will continue to produce goods until they no longer have a comparative advantage not to be confused with an absolute advantage. A government may levy a tariff on products that it feels could endanger its population. For example, South Korea may place a tariff on imported beef from the United States if it thinks that the goods could be tainted with a disease.

The use of tariffs to protect infant industries can be seen by the Import Substitution Industrialization ISI strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods while protecting those industries from being forced out by more competitive pricing.

It decreases unemployment and allows developing countries to shift from agricultural products to finished goods. Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the development of infant industries.

If an industry develops without competition, it could wind up producing lower quality goods, and the subsidies required to keep the state-backed industry afloat could sap economic growth.

Barriers are also employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection. For example, while both Western Europe and the United States are industrialized, both are very protective of defense-oriented companies.

Countries may also set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines "Champagne" a name specific to the Champagne region of France for too long, it may levy a tariff on imported meat from the United States.

If the U. Retaliation can also be employed if a trading partner goes against the government's foreign policy objectives. There are several types of tariffs and barriers that a government can employ:. A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff can vary according to the type of goods imported. The phrase "ad valorem" is Latin for "according to value," and this type of tariff is levied on a good based on a percentage of that good's value.

This price increase protects domestic producers from being undercut but also keeps prices artificially high for Japanese car shoppers. A license is granted to a business by the government and allows the business to import a certain type of good into the country. For example, there could be a restriction on imported cheese, and licenses would be granted to certain companies allowing them to act as importers.

This creates a restriction on competition and increases prices faced by consumers. An import quota is a restriction placed on the amount of a particular good that can be imported. This sort of barrier is often associated with the issuance of licenses. For example, a country may place a quota on the volume of imported citrus fruit that is allowed.

This type of trade barrier is "voluntary" in that it is created by the exporting country rather than the importing one. A voluntary export restraint VER is usually levied at the behest of the importing country and could be accompanied by a reciprocal VER. Canada could then place a VER on the exportation of coal to Brazil. This increases the price of both coal and sugar but protects the domestic industries. Instead of placing a quota on the number of goods that can be imported, the government can require that a certain percentage of a good be made domestically.

The restriction can be a percentage of the good itself or a percentage of the value of the good. In the final section, we'll examine who benefits from tariffs and how they affect the price of goods. The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased revenue as imports enter the domestic market. Domestic industries also benefit from a reduction in competition, since import prices are artificially inflated.

In pre-modern Europe, a nation's wealth was believed to consist of fixed, tangible assets , such as gold, silver, land, and other physical resources. Trade was seen as a zero-sum game that resulted in either a clear net loss or a clear net gain of wealth.

If a country imported more than it exported, a resource, mainly gold, would flow abroad thereby draining its wealth. Cross-border trade was viewed with suspicion, and countries much preferred to acquire colonies with which they could establish exclusive trading relationships, rather than trading with each other.

This system, known as mercantilism , relied heavily on tariffs and even outright bans on trade. The colonizing country, which saw itself as competing with other colonizers, would import raw materials from its colonies, which were generally barred from selling their raw materials elsewhere.

The colonizing country would convert the materials into manufactured wares, which it would sell back to the colonies. High tariffs and other barriers were put in place to make sure that colonies purchased manufactured goods only from their colonizers. The Scottish economist Adam Smith was one of the first to question the wisdom of this arrangement. His Wealth of Nations was published in , the same year that Britain's American colonies declared independence in response to high taxes and restrictive trade arrangements.

Later writers, such as David Ricardo , further developed Smith's ideas, leading to the theory of comparative advantage. It maintains that if one country is better at producing a certain product, while another country is better at producing another, each should devote its resources to the activity at which it excels.

The countries should then trade with one another, rather than erecting barriers that force them to divert resources toward activities they do not perform well. Tariffs, according to this theory, are a drag on economic growth, even if they can be deployed to benefit certain narrow sectors under some circumstances. These two approaches— free trade based on the idea of comparative advantage, on the one hand, and restricted trade based on the idea of a zero-sum game, on the other—have experienced ebbs and flows in popularity.

Relatively free trade enjoyed a heyday in the late 19th and early 20th centuries when the idea took hold that international commerce had made large-scale wars between nations so expensive and counterproductive that they were obsolete.

World War I proved that idea wrong, and nationalist approaches to trade, including high tariffs, dominated until the end of World War II. From that point on, free trade enjoyed a year resurgence, culminating in the creation in of the World Trade Organization WTO , which acts as an international forum for settling disputes and laying down ground rules. Skepticism of this model—sometimes labeled neoliberalism by critics, who tie it to 19th-century liberal arguments in favor of free trade—grew, however, and Britain in voted to leave the European Union.

That same year Donald Trump won the U. Critics of tariff-free multilateral trade deals, who come from both ends of the political spectrum, argue that they erode national sovereignty and encourage a race to the bottom in terms of wages, worker protections, and product quality and standards. The defenders of such deals, meanwhile, counter that tariffs lead to trade wars, hurt consumers, hamper innovation, and encourage xenophobia.

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