Tariffs are taxes on imports. They effectively raise the prices of those imports, providing an edge to domestic companies in the same markets. Governments usually impose tariffs to help domestic companies, or sometimes to punish foreign competitors for unfair trading practices. However, tariffs can also have harmful consequences for domestic companies, especially ones in related industries, as well as consumers.

Understanding Tariffs

Tariffs are paid by importing businesses to their own government, with most costs passed on to consumers of those goods or services somewhere down the line. Tariffs are not paid by foreign companies that produced the goods or the governments of their home countries. Tariffs are usually used to protect struggling domestic industries against foreign competition or unfair practices such as dumping and foreign government subsidies.

There are two basic types of tariff: an ad valorem tax and a specific tariff. An ad valorem tax, the most common type, is levied as a percentage of the value of the good or service. A specific tariff sets a fixed fee by weight or number of items.

Key Takeaways

  • Tariffs are a tax on imports paid by importing companies in the country that imposed the tax. The cost is usually passed on to consumers.
  • Tariffs are meant to protect domestic industries by raising prices on their competitors' products.
  • However, tariffs can also hurt domestic companies in related industries while raising prices for consumers.
  • Tariffs can also erode competitiveness in the protected industries.

The Declining Use of Tariffs

Most economists believe tariffs hinder trade and economic growth while raising prices for consumers in tariff-implementing countries. This is why their use has fallen dramatically since World War II. The average level of tariffs on industrial goods has fallen from about 40% at the end of the war to about 4% today. A 10% increase in trade is thought to raise per capita incomes by 4%.

Still, most countries maintain at least small tariffs on some goods, especially ones of special domestic importance. The U.S., for example, still keeps a tariff of 25% on light pickup trucks, while the European Union maintains a 10% import tax on cars from the U.S. and other countries.

Steel and the Ripple Effects of Tariffs

President Donald Trump's steel tariffs illustrate one way tariffs can be harmful as well as helpful. The U.S. steel industry has for years suffered from unfair trading practices overseas, particularly government subsidies that enabled Chinese producers to dump steel at low prices. In 2018, Trump imposed tariffs of 25% on steel imports in an effort to protect the domestic industry, including factory jobs in important "rust belt" swing states such as Pennsylvania.

While those tariffs have helped U.S. steelmakers, they have forced many U.S. companies that need steel for their products—especially automakers—to pay higher prices. This, in turn, can lead to higher prices for those downstream products and threaten jobs in downstream industries. There are 140,000 U.S. steelworkers and more than 5 million workers in steel-consuming manufacturing industries.

Tariffs and Higher Prices for Consumers

Trump's washing machine tariffs show how import taxes can raise consumer prices—and not just on the targeted imports. Research by the U.S. Federal Reserve found that while the washing machine tariffs brought in $82 million a year to the U.S. Treasury, the cost to U.S. consumers was $1.5 billion a year. That's because U.S. producers raised their prices on washing machines and a range of other goods.

The washing machine tariffs helped create about 1,800 manufacturing jobs, the Fed concluded, but the cost to the U.S. as a whole was about $817,000 per job.

The Bottom Line on Tariffs

As illustrated above, tariffs often end up hurting other domestic companies in related industries as well as consumers. Yet many economists also argue that they often protect weak companies that should be allowed to fail, and over the longer term they erode the competitiveness of viable companies because those companies aren't forced to compete on an even playing field with foreign firms.