There has been a lot of talk about tariffs over the last eight years, and in this election year, you are likely to hear even more. This is not anything new – debates in American politics over tariffs go back to the nation’s beginning. Alexander Hamilton, the nation’s first treasury secretary, asserted that tariffs were necessary at least temporarily to help “infant industries” in the United States until they grew strong enough to compete abroad, at which point tariffs can be removed. Variations of this argument have been advanced throughout U.S. history and have gained credence again in recent years.
Tariffs are, essentially, taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers.
Tariffs are paid when a good or service is imported into a country. 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’s important to note that tariffs are not a source of government revenue. Customs duties still make up just 2% of federal revenues — while the individual income tax made up almost half of federal receipts in 2023, according to the Office of Management and Budget.
Motivations for imposing tariffs range from revitalizing local industries (as Hamilton aimed for) to addressing unfair trade practices (as with recent efforts by recent administrations). Economists use a variety of methods to analyze how tariffs affect protected companies, consumers, importing firms, exporters, and our economy overall. They generally find that tariffs benefit some but hurt far more others, thus lowering overall living standards and economic growth.
How do Tariffs Work?
Sometimes, governments want to protect domestic producers and industries that may experience competition from cheap imported goods. They are commonly used in international trade as a protectionist measure, with the aim of giving advantages to domestic producers as well as raising revenue. In addition, supporting domestic producers prevents a potential increase in unemployment.
Tariffs protect emerging domestic industries by stimulating. growth and by making domestic products more available and attractive to consumers than imported goods.
For example, high tariffs on inexpensive, government-subsidized electric vehicles (EV) and batteries from China protect the American EV industry by preventing an influx of Chinese EV cars and products into the U.S. market. There are reports that China is producing 30 million EVs a year but can only sell 22 million to 23 million domestically. The Alliance for American Manufacturing has stated that the importing of seven million Chinese EVs into the U.S. market without tariffs would be an “extinction-level event” for U.S. carmakers.
As with most tariffs, manufacturers pass the cost on to the consumer, thus keeping U.S. EV prices competitive with China and preventing the cheaper goods from undercutting the billions of dollars of government investment that has been poured into this key manufacturing sector.
Tariffs are thus meant to give industries a respite to enable growth. Previous tariffs have largely kept affordable Chinese-made vehicles out of the U.S., even as they gain popularity in Europe and other markets. Tariff hikes are meant to ensure that doesn’t change.
The Trump administration levied tariffs on thousands of products valued at approximately $380 billion in 2018 and 2019. The Biden administration has kept most of the Trump administration tariffs in place.
In addition, in May 2024 the White House announced that President Biden had directed “his Trade Representative to increase tariffs under Section 301 of the Trade Act of 1974 on $18 billion of imports from China to protect American workers and businesses.” The White House stated that this came in response to “China’s unfair trade practices and to counteract the resulting harms.” The increases in tariffs were imposed across strategic sectors including electric vehicles, batteries, critical minerals, steel and aluminum, semiconductors, solar cells, ship-to-shore cranes, and medical products.
Former President Trump, in his 2024 campaign, has proposed tariffs on most foreign goods and suggested a tariff of 60 percent or more on goods from China. The Biden administration has said tariffs at that level could hurt the U.S. economy and lead to a global trade war that would negatively impact U.S. exporters.
Increasing tariffs to pay for even a modest tax cut would require a massive hike in import levies that would mean a big increase on consumer prices. Also, an increase in tariffs would inevitably cause substitution away from the products in question, which would limit any proceeds.
Who Pays?
Tariffs directly increase the cost of domestic sales by artificially increasing the price of imports.
While tariffs are often described as a tax on foreign businesses, the costs are often borne by consumers in the country that is imposing them. The taxes owed on imports are paid by domestic consumers. The effect is to make foreign products relatively more expensive for consumers. If manufacturers rely on imported components or other inputs in their production process, the firms will also pass the increased cost on to consumers.
Even if businesses end up absorbing some or most of the tariff, economists still see that as imposing a cost on consumers. Firms faced with higher prices might have to lay off workers or hold off on expansion. That could sap overall growth and ultimately still affect consumers, though some more than others.
If a car manufacturer imports engines that are then used in vehicles, then tariffs on those imported engines will increase the production cost and the cost to the consumer. The costs of tariffs result in higher burdens on international trade which can harm production. Many businesses have supply chains that cross multiple borders, and each border that is crossed could result in higher costs due to tariffs.
That does not mean that the country subject to the tariff is unaffected. As their exports become more expensive, firms may shift supply chains and consumers may shift their product preferences. The loss of market share can be costly.
According to the Tax Foundation, a non-partisan, Washington D.C.-based think tank in operation since 1937, both historical evidence and recent studies show that tariffs are taxes that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers, which results in lower income, reduced employment, and lower economic output. For example, the effects of higher steel prices, largely a result of the 2002 steel tariffs levied by the George W. Bush Administration, led to a loss of nearly 200,000 jobs in the steel-consuming sector, a loss larger than the total employment in the steel-producing sector at the time.
Recent empirical evidence indicates the new U.S. tariffs imposed in 2018 and 2019 were almost entirely passed on to U.S. consumers, resulting in higher prices and reduced export growth. A study by the non-partisan Cambridge, Mass.-based National Bureau of Economic Research in 2021 found that U.S. consumers bore the brunt of the tariffs on Chinese goods through higher prices. Other studies have pointed to different costs for consumers: with tariffs on their foreign competitors, domestic producers can safely raise their prices. Ultimately, consumers share the burden with importers.
Tariffs also tend to be regressive because the average shares of income sources burdened by tariffs are higher for lower-income taxpayers.
Retaliation and Inflation
Perhaps most important, tariffs often lead to retaliation. This places the country that first levied tariffs on the other side of the tariffs equation and ensures that both its consumers and its export industries will be hit.
For example, China responded to the tariffs in kind, while U.S. allies, including Canada and the European Union, retaliated against the levies placed on steel and aluminum products.
Firms that pay tariffs often pass them along in the form of higher prices. Research has established that higher tariffs are associated with higher levels of inflation in countries that apply them. The Peterson Institute for International Economics, a non-partisan Washington D.C.-based think tank, has estimated that removing all tariffs against China would lower annual inflation by a full 1%.
Analysts at Goldman Sachs estimated in a research note that every percentage point increase in the overall U.S. tariff rate would increase core consumer prices by roughly 0.1%
This provides an opportunity for domestic competitors to foreign industries to raise their own prices.
For example, when a tariff was placed on washing machines, the cost of dryers increased. This unintended consequence of protectionist policy are illustrated in a case study by economists Aaron Flaaen, Ali Hortaçsu, and Felix Tintelnot, “The Production Relocation and Price Effects of US Trade Policy: The Case of Washing Machines,” published in the American Economic Review in July 2020.
The study found that the price of dryers rose in lock step with the price increases in washers. While the average price of washers rose by $86 per unit, the average price of dryers rose by $92. Moreover, the study found that domestic producers raised their prices at the same rate as importers. Together, the price increases cost consumers more than $1.5 billion in the first year of the tariff’s implementation alone. Meanwhile, the study’ authors estimated that the cost to consumers for every job created or protected was quite high.
That study, as well as another by the U.S. International Trade Commission, suggests that imposing a 10% across-the-board tariff on imported goods would not improve the competitiveness of domestic producers but would raise prices on consumers and complementary goods and be costly for every job saved or created.
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