Tariff

Updated on January 31, 2024
Article byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

Tariff Meaning

A tariff is levied by a government on the import of goods or services from another country. The charges increase government revenue, restrict trade with other countries, and protect domestic manufacturers from stiff competition.

Governments try to impact other countries by implicitly increasing or decreasing import tariffs. If import taxes are kept high, imported goods become significantly costlier than domestic products. As a result, the demand for imported goods in the domestic market falls.

Key Takeaways

  • A tariff is a trade barrier; the government imposes taxes on the procurement of goods or services from foreign countries.
  • It is a strategic decision; using trade, governments try to control diplomatic relations with other countries.
  • The tax is paid by the importer, but the burden ultimately falls upon the final customers. This way, demand for a particular product in the domestic market is reduced.
  • Import barriers are father classified into ad valorem charges, specific charges, compound charges, and tariff-rate quotas.

Tariff Explained

Tariffs are trade barriers—they restrict the international exchange of goods and services. The local government imposes charges on the total value or quantity of products imported from foreign nations. The importer pays the tax, but the burden ultimately falls on the final customers. Import barriers are further classified into import duty, import quotas, standardization, and licenses.

Tariff

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Economists promote free-trade policies and highlight the importance of the cross-border exchange of goods and services for the economic growthEconomic GrowthEconomic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more of a nation. On the other hand, import barriers play a crucial role in safeguarding domestic manufacturers. Import taxes are usually planned courses of action; they can increase a nation’s employment rate, improve national security, initiate retaliatory action, or discourage a particular foreign nation.

When a government imposes taxes on imported goods, the price of that product will increase in the domestic market. As a result, the import of that particular product will decrease. Simply put, import barriers benefit domestic producers and detract importers of foreign goods. Like all taxes, import barriers are sources of revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more for the government.

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Types of Tariffs

Primarily the charges are subdivided into four different types:

  1. Ad valorem Tariff: It is imposed as a percentage of the total value of goods purchased from a foreign country. The tax liability increases with an increase in the value of goods.
  2. Specific Tariffs: It is levied as a particular dollar amount on the number of units purchased from a foreign nation. The tax amount depends on goods quantity and not on goods value.
  3. Compound Tariffs: It is a blend of ad valorem and specific taxes. It is imposed both on goods quantity and on goods value. A dollar amount is charged depending on the number of units. In addition, a percentage of the total value of imported products is levied.
  4. Tariff-rate Quota: Imported goods are taxed at a certain rate up to a particular limit. Thus, applicable tax varies depending on the quantity. For example, a 5% tariff is levied on brown sugar consignments smaller than 1000 kgs. A 10% tax is imposed on Brown sugar imports ranging between 1000kgs and 10,000 kgs.

Examples

Let us look at some foreign trade examples to understand the practical application of import taxes:

Example 1

Import barriers are interlinked with trade relationships between nations. In 2022, US president Biden terminated tariffs imposed on the US import of steel from Ukraine. It was an attempt to support Ukraine’s economy. The production and export of steel play a major role in Ukraine’s economy—it is a massive source of employment.

America has been an importer of Ukrainian steel for years. In 2018, however, former President Trump imposed a 25% tariff on steel imports.

During the war, Ukrainian steel plants had been cut off from some of their more traditional markets in the Middle East and Africa. In order to continue the steel trade, steel will be exported through rail transport from Ukraine to the US, Europe, and Britain markets via Romania.

Example 2

In May 2022, Tesla put its India entry plans on hold after a deadlock on tariffs. Tesla has stopped pursuing showroom spaces in India. Instead, the workforce is reassigned to other countries.

The decision was taken after a year-long negotiation. Tesla wanted to test the demand for electric vehicles (EVs) by importing them from the US. But, the Indian government was inclined towards local manufacturing; import taxes were not lowered. Potentially, Tariffs on imported vehicles can run as high as 100%.

Frequently Asked Questions (FAQs)

How do tariffs work?

To execute a cross-border exchange of goods or services, the importer must fill out the customs form to declare any due charges (as per the Harmonized Tariff Schedule). The charges are paid by parties involved in the trade. Customs releases goods only after the completion of payment.

How are tariffs calculated?

Ad valorem taxes are determined as a government-specified percentage charged on the total value of imported goods. However, specific charges depend on the number of units imported. It is charged per unit of goods and then multiplied by the total units.

Are tariffs good or bad?

It is an indirect source of revenue for the government. Compared to other massive sources, the benefits are negligible. But it significantly affects the consumers—imported goods become very expensive when the government imposes high import charges. On the opposite spectrum, it can really help local manufacturers. Sometimes, local manufacturers cannot compete with imported goods or services; that is when governmental charges on imports come to the rescue.

This has been a guide to what is Tariff and its meaning. We discuss tariff rate quotas, definition, types, customs, import barriers, harmonized tariff schedule, and trade examples. You can learn more about it from the following articles –

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