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What is a 'Tariff'

A tariff is a tax imposed on imported goods and services.

BREAKING DOWN 'Tariff'

Tariffs are used to restrict imports by increasing the price of goods and services purchased from overseas and making them less attractive to consumers. A specific tariff is levied as a fixed fee based on the type of item, for example, $1,000 on any car. An ad-valorem tariff is levied based on the item's value, for example, 10% of the car's value.

Governments may impose tariffs to raise revenue or to protect domestic industries – particularly nascent ones – from foreign competition. By making foreign-produced goods more expensive, tariffs can make domestic-produced ones more attractive. By protecting these industries, governments can also protect jobs. Tariffs can also be used as an extension of foreign policy: imposing tariffs on a trading partner's main exports is a way to exert economic leverage.

Tariffs can have unintended side-effects, however. They can make domestic industries less efficient by reducing competition. They can hurt domestic consumers, since a lack of competition tends to push up prices. They can generate tensions by favoring certain industries over others, as well as certain regions over others: tariffs designed to benefit manufacturers in cities may hurt consumers in rural areas, who do not benefit from the policy and are likely to pay more for manufactured goods. Finally, an attempt to pressure a rival country using tariffs can devolve into an unproductive cycle of retaliation, known as a trade war.

History of Tariffs

In the pre-modern Europe, a nation's wealth was believed to consist of fixed, tangible assets such as gold, silver, land and other physical resources (but especially gold). Trade was seen as a zero-sum game that resulted either in a clear net loss of wealth or a clear net gain. If a country imported more than it exported, its gold would flow abroad, draining its wealth. Cross-border trade was therefore looked at with suspicion, and countries much preferred to acquire colonies they could set up exclusive trading relationships with, rather than trading among themselves. 

This system, known as mercantilism, relied heavily on tariffs and even outright bans on trade. The colonizing country, which saw itself as competing with other colonizers, would import raw materials from its colonies; these were generally barred from selling raw materials elsewhere. The colonizing country would convert these materials into manufactured wares, which it would sell back to the colonies. High tariffs and other barriers were put in place to make sure that colonies only purchased manufactured goods from their colonizers. 

Adam Smith was one of the first to question the wisdom of this arrangement. His Wealth of Nations was published in 1776, the same year that Britain's American colonies declared independence in response to high taxes and restrictive trade arrangements. Later writers such as David Ricardo further developed Smith's ideas, leading to the theory of comparative advantage: if one country is better at producing one product, while another country is better at producing another, each should devote its resources to the activity at which it excels. They should trade with one another, rather than erecting barriers that force them to divert some resources towards activities they do not perform well. Tariffs, according to this theory, are a drag on economic growth, even if they can be deployed to benefit certain narrow sectors under certain circumstances.

These two approaches – free trade based on the idea of comparative advantage, on the one hand, and restricted trade based on the idea of a zero-sum game, on the other – have experienced their ebbs and flows. Relatively free trade enjoyed a heyday in the late 19th century and early 20th, when the idea took hold that international commerce had made large-scale wars between states so expensive and counterproductive that they were obsolete. World War I proved that idea wrong, and nationalist approaches to trade (including high tariffs) dominated until the end of World War II.

At that point free trade enjoyed a 50-year resurgence, culminating in the creation in 1995 of the World Trade Organization, which acts as an international forum for settling disputes and laying down ground rules. Free trade agreements such as NAFTA and the European Union also proliferated. Skepticism of this model – sometimes labeled "neoliberalism" by critics, who tie it to 19th-century liberal arguments in favor of free trade – grew, however, and Britain voted to leave the European Union in 2016, while Donald Trump won the U.S. presidential election in the same year on a platform that called for steep tariffs on Chinese and Mexican imports.

Critics of multilateral trade deals to eliminate tariffs – who come from both ends of the political spectrum – argue that these deals erode national sovereignty and encourage a race to the bottom in terms of wages, worker protections, quality and standards. Their defenders argue that tariffs lead to trade wars, hurt consumers, hamper innovation and encourage xenophobia.

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