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Updated on Friday, August 24, 2018
By now, you’ve probably heard that President Donald Trump wants to up the ante in his trade war with China by unleashing a new round of tariffs. And maybe you remember his metals tariffs that hit the European Union earlier this summer, and now he’s threatening to double metals tariffs for Turkey. But perhaps what you’ve really been wondering all along is: What is a tariff, anyway?
Let us fill you in on some important context before you dive back into the latest trade tension escalations.
A tariff is a tax that the federal government levies on imported products. It’s often charged as a percentage of the value of a product that a U.S. buyer pays a foreign exporter.
For instance, the general tariff rate on an imported dishwasher is 2.4%. If a foreign exporter sets the price at $500, an American importer would have to pay an additional $12 tariffs on the machine, which makes the dishwasher’s total import price $512.
In the U.S., tariffs are collected at 328 ports of entry, which are controlled by Customs and Border Protection (CBP).
In order to get the foreign goods cleared through customs, U.S. importers have to pay the duties, which they are likely to pass on to consumers later.
The money paid on imported goods flows into the Department of the Treasury. Customs duties make up a small fraction of the federal government’s revenue.
How much are the tariffs?
The United States is one of the world’s largest importers. In 2017, the U.S. imported goods worth $2.4 trillion from other countries. China, Canada and Mexico are America’s top three trading partners.
U.S. tariffs are on the low end among countries in the world. Most foreign goods enter the U.S. duty-free, such as industrial goods and raw material like oil. In 2016, according to The World Bank, the average applied U.S. tariff across all products was 1.7%. In comparison, China placed an average 3.5% tariffs on imported items, and Canada’s applied tariff rate was 1.6%.
Only 30% of the total U.S. imports in 2017 were subject to tariffs, and the average duty applied to those items was less than 5%, according to the Pew Research Center.
The U.S. International Trade Commission listed U.S. tariffs on everything from orange marmalade (3.5%) to dishes (6.5%) in its detailed Harmonized Tariff Schedule.
How are tariff rates decided?
Countries apply different rates of tariffs on different types of products imported from different countries. Some countries have high tariffs on imports, while others are low-tariff countries.
Within the World Trade Organization (WTO) system, members agree to not charge tariffs on imports above certain levels, which are set forth by the WTO in detailed schedules.
Countries can also negotiate tariffs on imports and exports through bilateral or regional agreements, such as the North American Free Trade Act (being renegotiated now), as long as the rates are within the WTO tariff limits.
The U.S. has free-trade agreements (FTA) with 20 countries. FTAs reduce trade barriers, eliminating tariffs charged on products traded between partners. This year, the U.S. has upset some of its trading partners, such as Canada and Mexico, by applying steep tariffs on steel (25%) and aluminum (10%), which we will discuss in a second.
“Once you get into a trade war, it seems like the trade war supersedes any previous agreements you might have,” said Mark Perry, an economics policy scholar at the American Enterprise Institute and professor of finance and business economics at the University of Michigan-Flint.
Trump’s trade war tariffs
To protect certain domestic industries, the U.S. — as well as other countries — sometimes impose additional tariffs, or penalty tariffs, on foreign imports if it determines there is unfairness in trade or some damage to the U.S. economy.
“That’s what you’re talking about when you’re talking about steel and aluminum tariffs that Trump put on,” said Gary Hufbauer, economist and nonresident senior fellow at the Peterson Institute for International Economics (PIIE). “His view, which many disagree with, including me, is that imported steel and aluminum threatens the national security of the United States, so we put on extra tariffs on those.” PIIE is a nonprofit, nonpartisan economics research institution in Washington, D.C.
Imposition of harsh tariffs is both an economic tool and a foreign policy tool. But Trump is wielding it mostly as a foreign policy tool to punish other countries, including U.S. allies, citing national security concerns, which is unusual, said experts who also question the economic benefits.
Penalty tariffs are often much higher than the single-digit regular tariffs. Trump has slapped tariffs of up to 25% on foreign imports so far. Countries hit with Trump’s tariffs include China, Canada, E.U. nations, South Korea, Brazil, Argentina, Turkey and Australia.
Before Trump came into office, about 4% of U.S. imports were covered by penalty tariffs, PIIE researchers estimated in a 2017 study. This figure could increase to 7.4% if the Trump administration were to follow through on the tariff barriers announced during Trump’s first 100 days in the office. That was before Trump threatened to slap new tariffs on billions worth of Chinese imports.
A backlash could hurt American companies who export overseas. Targeted countries often retaliate against U.S. exports, hurting certain domestic industries as foreign demands drop. Companies that heavily relied on exports may slash staff, which could have an impact on the labor market, Perry said.
How much of the tariff gets passed on to consumers?
Duties are incorporated into the retail prices of products, differentiating from your local and state sales taxes. How much duty consumers have to pay on each item depends a lot on the product and on the country from which the product comes into the U.S.
On average, consumers have to bear about half to two-thirds of the tariffs on imported products, according to economists. The rest is absorbed by U.S. companies and/or foreign exporters.
Stiff tariffs on raw materials make it more costly for American manufacturers to produce products, which in general ultimately translate to higher prices on consumer products sold at retail stores.
“The prices would go up for consumers both for the imported goods and then also for the protected goods from the protected industry or protected manufacturer in the U.S. who now is able to raise prices because of less competition,” Perry said.
Sometimes the entire cost of penalty duties gets passed on to consumers. This is because the U.S. imports many types of specialized machinery that have to be approved by some government agencies, for instance, medical equipment, and there may be only one supplier who makes that product. Due to a lack of alternative import sources, the exporter isn’t likely to make a concession, so the U.S. importer is responsible for the full tariff amount and passes it on to consumers, Hufbauer explained.
For lower-end products where a lot of foreign suppliers compete with one another to sell to America, the consumer impact is next to zero. Take T-shirts as an example.
“If you put a tariff on T-shirts from one country, if they want to continue to export in competition with all the other countries, they will have to absorb the tariffs, meaning they will have to cut their prices by the amount of apparel,” Hufbauer said.
Tariffs: A brief history
With all of this chaos caused by tariffs, you may be wondering how President Trump is able to single-handedly wield such a powerful tool. Congress has delegated much of the decision-making power to the president, but there are signs the chambers may want to take it back. Sen. Mike Lee of Utah introduced a bill last year that would require congressional approval for certain trade actions.
But trade upheaval is nothing new here. Tariffs have a long history in the U.S., back to the beginning of the country in the 1700s. Because the country was saddled with debt from the Revolutionary War and had no federal income tax until 1913, customs duties were a major source of revenue for the federal government until the end of the Civil War.
Tariffs were a testy issue in the 19th century, too. The Republican Party, which had close ties to industrial firms, put harsh tariffs on imports to protect U.S.industries, reducing competition from counterparts from Great Britain and France, Hufbauer said.
The state of economic isolation continued through the dawn of the Great Depression. When the infamous Smoot-Hawley Tariff Act was enacted in the 1930s, world trade almost came to a standstill, which further damaged the already-troubled U.S. economy.
“That was kind of the last straw maybe that really turned it from a recession into a depression,” Perry said.
Since World War II, the U.S. has more or less moved in the direction of open trade, until now — tariffs are coming back as Trump further implements his protectionist trade agenda.