A few weeks ago (July 2018), I led a seminar on international trade for high school students which brought home to me how much misunderstanding exists about what is a tariff. The assumption was that tariffs are inherently protectionist. The current use of tariffs by the Trump Administration to protect the U.S. steel and aluminum industry makes it easy to reach that conclusion. But many countries impose tariffs on products even when there is no domestic industry to protect. Let’s take a step back to understand what is a tariff.
A tariff is a tax that is imposed on a product at the border. It is an instrument or tool of trade policy. Countries use tariffs to achieve different policy goals.
Raise Revenue: Taxing goods as they enter the country is an easy way to raise revenue for the national budget. The importers are a captive audience because they need to pay the duty or tariff in order to get their goods. In 1912, the United States average duty rate was 20% and the revenue raised from the tariffs contributed almost one-third of its budget. Because tariffs get added to the cost of the goods being sold, they operate as a regressive tax – everyone pays the same tax on the same product, rich or poor. For this reason, the U.S. today relies on other forms of taxes to raise revenue. Taxes paid by individuals and corporations contribute just over 90% of the US national budget. The average U.S. duty rate in 2017 was 1.4% and about two-thirds of imports entered the United States duty-free.
While this pattern is true for most developed economies, many developing economies continue to rely on tariffs as a primary source of revenue. This goal explains high tariffs on cars and computers, for example, by countries without the industrial base to produce them. As highly desired products, governments anticipate that these goods will be purchased even if a 100% duty has doubled the original price. Bhutan, for example, one of the world’s Least Developed Economies (LDCs), had an average duty rate of 22.6% in 2016 with some goods attracting 100% duty rate. Nepal, another LDC, had an average tariff rate of 16.8% and relies on customs duties for 20% of its revenue.
Protect Domestic Industry from Competition: Using tariffs with the goal of making imported goods more expensive and therefore less appealing to the consumer is protectionism. The steel products on which the Trump Administration has imposed a 25% duty previously entered the United States completely duty-free. About four-fifths of the aluminum products now subject to the 10% duty had also previously entered duty-free. More generally, the United States has always used tariffs to protect certain industries, notably its apparel and clothing industry. Almost 80% of apparel and clothing accessories imported into the United States has to pay a high tariff, which averages 18.7%. Countries such as Brazil and Japan are also notorious for using high tariffs to protect their domestic industries.
Health & Safety: Alcohol and tobacco products attract the highest tariffs in general. Some countries, like the United States, seek to protect local industry. Other countries use a combination of tariffs and sales taxes (imposed when the product is bought) to deter consumption of these products, while also raising revenue. Countries also rely on other trade policy tools, such as requiring that a product be licensed to enter the country, to address health and safety concerns. These requirements if unreasonable, can also act as non-tariff barriers (NTBs) to trade.
Like any tool, the effect and effectiveness of tariffs as an instrument of trade policy, depend on how it is used. A hammer can be used to smash through drywall, or to precisely remove an unwanted nail. Inappropriate use of tariffs and of NTBs can, and do, produce unwanted results. This is why the tariff policy of the Trump Administration has generated such concern and is being watched so closely.