What are Tariffs and How do They Affect the Economy?

Tariffs to Raise Revenue

As a tax, tariffs raise revenue for governments. In the past, they have been a major contributor to government funds. For example, in the early part of U.S. history, the majority of the federal government's funds came from tariffs as Congress could not levy taxes. Although some politicians still talk about raising revenue through tariffs, the advent of income taxes means they rarely contribute a large percentage to the coffers of modern governments.

Tariffs to Protect Domestic Industry

The most common reason to impose tariffs is to protect a country's own industries. This can help protect industries that are just starting out, also known as infant industries, or protect industries that are considered special to a country. For example, in New Zealand tariffs help to protect the country's dairy industry. The theory behind this sort of tariff is that if imports are more expensive, consumers will choose to buy local products.

Tariffs to Protect Against Unfair Practices

Some nations invoke tariffs as a way to protect against dumping or unfair practices. These unfair practices occur when other nations have policies or take actions that make their products significantly cheaper. Types of dumping include:

• Environmental dumping, where fewer environmental regulations lead to cheaper production costs
• Social dumping, where social standards are kept low, such as through weak labor laws
• Tax dumping, where countries have very low personal or corporate tax rates

Tariffs as a Bargaining Tool

Some countries also use tariffs, or the threat of tariffs, as bargaining chips in trade wars. The threat of tariffs can be used as a legitimate negotiating tool but may backfire. In particular, countries often apply tariffs in a tit-for-tat manner, leading to businesses in both countries paying more taxes. For example, the U.S. has a tariff of 25 percent on light trucks and SUVs. This "chicken tax" was imposed by the Johnson administration as punishment for a European tariff on chickens. The tariff still exists more than 50 years later, despite the trade spat being over long ago.

What Goods do Tariffs Affect?

Tariffs can affect any goods that are being imported into a country. In the past, they have often been imposed on manufactured goods in order to protect high-paying manufacturing jobs. However, they can also be imposed on raw materials, so while a consumer may believe they're buying a tariff-free sweater, manufactured in the United States, it's possible that the manufacturer paid tariffs on the wool used to make the clothing. Tariffs are also imposed on many foods to encourage consumers to buy products from local farmers.

Who Pays the Tariff?

Technically the person or company importing a product pays the tariff. However, companies have the choice to pay these costs themselves, pass them on to the consumer, or some combination of the two. If a company has enough buying power, they may also force the foreign company to lower their prices, leading to less money for the manufacturer. In the end, tariffs lead to someone, whether importer, exporter or customer, having less money.

How do Tariffs Affect the Economy?

Pro-tariff economists say that tariffs lead to diversification of economies which make them stronger overall. They point to free trade agreements imposed on third world countries in the 1800s that led to stagnant economies still causing problems today. Free trade proponents claim tariffs have unintended consequences. While tariffs on steel may help protect steelworkers, it can drive up the price of materials leading to lower profits and job losses in downstream industries that use that steel. This eventually leads to a shrinking economy.

Benefits and Drawbacks of Free Trade

Free trade has many benefits to consumers and the economy. It helps ease inflation and increases access to higher-quality goods. It also encourages innovation and competition as local companies find efficiencies that help them keep up with international competitors.

While some economists believe free trade increases fairness, this can be difficult to see. Pro-tariff economists point to workers in sweatshops that earn $1 a day making sneakers for western markets. There are often few incentives for companies to improve working conditions when profits remain high using these workers.

Protection Through Free Trade

Most countries today use a mix of tariffs and free trade agreements to help keep their economies growing. Where tariffs were once used to protect against unfair practices, many free trade agreements now use language that enforces minimum environmental and labor regulations on member countries. This not only protects local workforces from unfair competition but also increases worker's rights around the world.

The Future of Tariffs

In many countries, a wish for protectionism is increasing, seen most clearly in Britain voting to leave the free trade block of the European Union. However, it's unlikely that free trade will go away anytime soon. Politicians will look to the examples of economies that are growing and emulate the steps they take, bringing prosperity to both the local and global economies.