The Truth About Tariffs
Backgrounder

The Truth About Tariffs

Tariffs have been applied over the years to protect homegrown industries and target competitors who are seen as using unfair trade practices. They impose costs on both importers and exporters and had been in decline until the recent U.S.-China trade spat.
A steelworker tests a sample of steel at an Indiana mill in March 2018.
A steelworker tests a sample of steel at an Indiana mill in March 2018. Scott Olson/Getty Images
Summary
  • Tariffs are a form of tax applied on imports from other countries. Economists say the costs are largely passed on to consumers.
  • They have historically been used to protect domestic industries, including agriculture and automobiles, as well as to retaliate against other countries’ unfair trade practices.
  • U.S. President Trump wielded tariffs more than any recent president, particularly against China, and President Biden has so far left these levies in place.

Introduction

Tariffs have long been used to prop up homegrown industries by inducing citizens to buy goods produced domestically. Since the end of World War II, however, tariffs have largely fallen out of favor in developed economies because they often lead to reduced trade, higher prices for consumers, and retaliation from abroad. 

More From Our Experts

President Donald Trump broke with this economic orthodoxy and imposed tariffs on hundreds of billions of dollars worth of imported goods from China and other countries in an effort to combat alleged unfair trade practices, reduce the U.S. trade deficit, and boost domestic manufacturing in the name of national security and U.S. economic competitiveness. President Joe Biden has left these tariffs in place, leading some experts to fear that they will become a permanent part of the U.S. trade landscape.

What is a tariff?

More on:

Trade

Economics

United States

China

Donald Trump

A tariff is a tax imposed on foreign-made goods, paid by the importing business to its home country’s government. The most common kind of tariffs are ad valorem, which are levied as a fixed percentage of the value of the imports. There are also “specific tariffs,” which are charged as a fixed amount on each imported good (for example, $2 per shirt) and “tariff-rate quotas,” which are tariffs that kick in or rise significantly after a certain amount of imports is reached (e.g., fifty thousand tons of sugar).

Tariffs can serve several goals. Like all taxes, they provide a modest source of government revenue. Several countries have also used tariffs to help fledgling industries at home, hoping to shelter those local firms from foreign competitors. Some tariffs are also meant to address unfair practices that other countries have used to make their exports artificially cheap.

Who uses tariffs?

Almost every country imposes some tariffs. In general, wealthy countries maintain low tariffs compared to developing countries. There are several reasons why: developing countries might have more fragile industries that they wish to protect, or they might have fewer sources of government revenue. The United States, for instance, maintained high tariffs for decades, until income taxes supplanted tariffs as the most important source of revenue. After World War II, tariffs continued to decline as the United States emphasized trade expansion as a central plank of its global strategy.

More From Our Experts

Who authorizes tariffs in the United States?

The Constitution grants Congress the power “to regulate commerce with foreign nations, and among the several states,” which it used for more than a century to impose tariffs. Perhaps most infamous, Congress raised close to nine hundred separate tariffs with the 1930 Smoot-Hawley Tariff Act, which many economists say worsened the Great Depression. But over the past ninety years, Congress has delegated more and more trade authority to the executive branch, in part a response to its mistakes in Smoot-Hawley.

Several pieces of legislation underline this trend. The Reciprocal Trade Agreements Act of 1934 gave President Franklin D. Roosevelt the power to negotiate tariff-cutting trade deals with other countries. This was followed by the Trade Expansion Act of 1962, which granted the president authority to negotiate tariff reductions of up to 80 percent. The Trade Act of 1974 [PDF] allowed the executive branch to strike trade deals—with negotiating objectives set by Congress—that were then subject to an unamendable up-or-down vote, known as fast-tracking. Both Democratic and Republican presidents have used this authority to lower tariffs and enter into a range of trade deals, including the agreement establishing the World Trade Organization (WTO). 

More on:

Trade

Economics

United States

China

Donald Trump

These laws also give the president the power to raise tariffs if foreign countries are found to be engaged in unfair trading practices, or if imported goods are deemed to be threatening critical domestic industries and thus harming national security. They also allow the president to impose tariffs if domestic industries are “seriously injured” by import competition, even if there is no alleged foul play. Many presidents have exercised these powers, though President Trump did so to a far greater extent than most of his predecessors, imposing tariffs affecting hundreds of billions of dollars worth of goods from China and other countries. Trump’s unconventional use of trade laws prompted a debate in the United States over whether Congress abdicated its constitutional authority over trade—and sparked legal challenges. Several lawmakers have since proposed legislation to rein in the president’s power to impose tariffs. 

Additionally, the WTO sets limits on the tariffs that countries can impose. WTO members are supposed to keep their tariffs below an agreed level, or bound rate, which varies among countries. (Developing countries are generally permitted to have higher tariffs.) When a country wins a dispute at the WTO, it is often allowed to impose retaliatory tariffs to pressure the losing country to change its policies. Many experts say that Trump’s decision to bypass the WTO and unilaterally impose tariffs damaged the organization’s credibility. CFR’s Jennifer Hillman and Alex Tippett have written that the Biden administration appears to share its predecessor’s view of the WTO, which could “fatally compromise the organization.”

What are the aims of tariffs?

Tariffs are intended to protect local industries by making imports more expensive and driving consumers to domestic producers. In the United States, several politically sensitive industries benefit from such tariffs: sugar producers have been protected by tariffs since 1789; and the auto industry has benefited from the so-called chicken tax since 1964, which places 25 percent tariffs on some pickup trucks. Additionally, tariffs are used to shield domestic industries from foreign countries’ unfair trading practices and, in some cases, for national security purposes. They can also be a tool of industrial policy.

Tariffs are intended to protect local industries by making imports more expensive and driving consumers to domestic producers.

Unfair trading practices. Some tariffs are meant to counteract specific measures taken by foreign countries or firms. For instance, the United States applies “countervailing duties” when another country subsidizes a domestic industry—allowing its exporters to sell products at a lower price than they would otherwise be able to in a free market—and thereby undercuts U.S. producers. “Antidumping tariffs” are applied when a U.S. firm proves that a foreign firm is selling products in the United States at lower prices than they charge at home, often in an attempt to drive competitors out of an industry before raising prices. In both of these cases, tariffs are meant as a penalty that allows domestic producers to compete as if the market had not been distorted. Critics, however, claim that even these tariffs are often disguised protectionist policies.

In 2018, under the auspices of Section 301 of the Trade Act of 1974, the Office of the U.S. Trade Representative (USTR) issued a report [PDF] detailing how China’s intellectual property (IP) practices were “unreasonable or discriminatory, and burden or restrict U.S. commerce.” These included pressuring American companies to hand over their IP as a condition for doing business in China, known as forced technology transfer. The report also highlighted Beijing’s “Made in China 2025” plan to achieve dominance in several high-tech sectors. On the basis of the report, Trump imposed a slew of tariffs, ultimately covering roughly $360 billion worth of imports from China. In October 2021, Trade Representative Katherine Tai announced that the Biden administration will keep these tariffs in place but allow U.S. companies to apply for exemptions. 

National security. In some strategic industries, often for goods with military uses, tariffs can be used to ensure a country does not rely on trade for its supply of critical products. Most notably, Section 232 of the Trade Expansion Act of 1962 allows the president to raise tariffs on certain goods for national security reasons. 

In an effort to curb China’s massive steel production, Trump used this law to raise tariffs on steel and aluminum imports from China, as well as from allies including Canada and the European Union (EU), leading to accusations that national security was being used as a pretext for protectionism. (Tariffs on Canada and Mexico were later dropped as part of the U.S.-Mexico-Canada Agreement.) Trump frequently threatened to impose tariffs on imported cars using the same authority, though the proposal drew fierce opposition from U.S. businesses and lawmakers. Biden has so far kept Trump’s steel tariffs, though his administration is reportedly in talks with the EU on lifting them. The use of Section 232 is particularly controversial, experts say, because it exploits an exception to WTO rules for actions taken in the name of national security. 

Economic competitiveness. Some arguments for tariffs are rooted in grand strategy. 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 grow 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. 

Trump and some of his advisors tout tariffs as an effective tool for bringing manufacturing jobs back to the United States and reducing the U.S. trade deficit. Biden’s Build Back Better plan amid the COVID-19 pandemic includes reshoring some production to ensure supply-chain resilience, and his administration has stressed the importance of manufacturing jobs.

Who pays?

Importers pay tariffs to their home government. Most economists find that the bulk of tariff costs are passed on to consumers. This is particularly true for industries, such as retail or grocery stores, with small profit margins. A 2019 study by researchers from the Federal Reserve and the University of Chicago found that consumers bore more than 100 percent of the costs of washing machine tariffs, indicating that appliance retailers charged even more than the tariffs had cost them. Some more recent research [PDF] has found that U.S. consumers have “borne the brunt” of the tariffs on Chinese goods through higher prices. Still 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. 

At the same time, exporters can cut prices to hold on to their market share. Most empirical research on recent U.S. tariffs suggests this has not occurred, but economists agree it is a possibility. Tariffs can hurt exporters by making their products more expensive. They could struggle to maintain their sales or be forced to cut prices, which could cause profits to fall and potentially damage their home country’s economy.

The effect is particularly worrisome for countries whose economies are export-driven, including many of those in Asia. China became the world’s largest exporter in 2009, and Vietnam has become a hub for low-cost manufacturing exports. More recently, some high-income countries, such as Germany, have turned to exports to support their growth. Companies in countries that depend on exports for growth can lose customers when hit with tariffs, resulting in strong economic headwinds. Experts say that Trump’s tariffs contributed to a slight decline in China’s economic growth, though the effects are difficult to measure since growth was already slowing before the tariffs took effect. 

What is the impact on tariff-wielding countries?

Most economists say that tariffs act as an economic drag in the countries using them. When consumers bear the brunt of tariff costs, it makes them effectively poorer because prices are higher. 

Firms that use domestic products as inputs also see their purchasing power shrink, as tariffs allow domestic producers to raise prices. For example, as automakers pay more for steel, economists suggest they are likely to shed more workers than steel mills will hire. One study by economists at Harvard University and the University of California, Davis, found that U.S. jobs in steel-using industries outnumbered jobs in steel-producing industries by an eighty-to-one ratio

Many experts challenge the logic behind tariffs and suggest they hurt more industries than they help, but some favor them. Robert E. Scott of the Economic Policy Institute, a pro-labor think tank, found that, as of late 2018, hundreds of jobs had been created in the aluminum sector and that there was “no evidence of the negative downstream effects” that many had forecast. Others point out that U.S. taxpayers have subsidized those jobs: a 2019 analysis by the Peterson Institute for International Economics found that each new steel job created cost consumers $900,000 per year. CFR’s Benn Steil and Benjamin Della Rocca have written that the steel tariffs are a “costly failure.”

Perhaps most important, tariffs often lead to retaliatory tariffs. These place the country that first levied tariffs on the other side of the equation and ensure that both its consumers and its export industries will be hit. China responded to Trump’s tariffs in kind, while U.S. allies, including Canada and the European Union, retaliated against the levies on steel and aluminum products. Countries often target the sensitive U.S. agriculture sector, which is reliant on exports.

What can countries do to mitigate the effects of tariffs?

The most common way for countries to fight back against tariffs—aside from levying retaliatory tariffs—is to subsidize the domestic industries that have been hit. The Trump administration countered tariffs on agricultural products by providing farmers with tens of billions of dollars in aid to make up for lost exports. Many economists criticized this strategy as counterproductive and wasteful. Some fear that recipients come to rely on such assistance programs, making them difficult to end. 

Some experts suggest that export-dependent countries could let their currencies depreciate in the face of tariffs. This would effectively cheapen exports and make them competitive despite tariffs. But it would also make consumers in that country poorer, as the local currency would have less purchasing power. Another remedy is to find alternative markets for imports and exports. Trump encouraged this, suggesting that companies facing tariffs on imports from China turn to Vietnam and other countries for their products. However, in testimony to the USTR’s office, many U.S. businesses complained that they were unable to quickly shift to sourcing products from outside of China, given the country’s dominance in manufacturing consumer products, and were therefore forced to pay the tariffs.

Once imposed, tariffs are difficult to remove because companies become used to the new environment and lobby against lifting them, experts say.

Ultimately, it might not be possible to reverse their effects. Once imposed, tariffs are difficult to remove because companies become used to the new environment and lobby against lifting them, experts say. The chicken tax on pickup trucks, for example, was imposed during a trade spat with the EU in 1964, yet has remained in place. If tariffs lead trading partners to find new buyers and sellers, those new relationships can endure.

Recommended Resources

This Peterson Institute for International Economics timeline tracked the major actions Trump took on trade.

CFR’s Edward Alden and Jennifer Hillman discuss what Biden’s trade policy could look like on The President’s Inbox podcast.

Dartmouth College economist Douglas A. Irwin traces the history of U.S. trade policy in his book Clashing Over Commerce

The Economist examines the changing global trade landscape in this special report.

For Foreign Affairs, then U.S. Trade Representative Robert Lighthizer argued that the United States should chart a path between protectionism and globalism.

For media inquiries on this topic, please reach out to [email protected].
Close

Top Stories on CFR

Trade

President Biden’s goal of bolstering democracies around the world will need robust U.S.-Europe cooperation to succeed.

Energy and Environment

The Biden administration has unveiled plans to dramatically ramp up the nation’s offshore wind industry to help fulfill U.S. climate pledges. How realistic is the roadmap?

COVID-19

Western rhetoric on partnering with African countries as equals appears hollow as Western nations slap travel bans on African countries with confirmed cases of the Omicron variant of COVID-19.