What is a Tariff? Understanding Their Impact on Businesses

Knowing the answer to “What is a tariff in economics?” is important for your business to make informed decisions about pricing, sourcing materials, and managing costs. Additionally, understanding the effects of tariffs on small businesses can help you navigate trade regulations, avoid unexpected expenses, and stay on top of the ever-competitive market.

In this article, we’ll answer the “What is a tariff tax?” question in detail, explaining how tariff policies work and their role in international trade. We’ll also explore the history and reasons behind levying tariffs, shining a light on both their positive and negative sides from the perspectives of businesses and consumers.

Let’s dive in!

Key Takeaways

• Understanding what a tariff is can largely benefit small businesses, whether they depend on imported materials or seek to establish their place in the competitive market.
• A tariff is a form of tax placed on imported goods when they cross the national border.
• Types of tariffs include protective, revenue, specific, ad valorem, compound, retaliatory, and anti-dumping tariffs.
• Countries impose tariffs to raise revenue, protect local businesses, and correct trade imbalances.
• Some of the most recent examples of tariffs include the US-China trade tariffs and EU steel tariffs.

What is a Tariff?

A tariff is a form of tax a government places on foreign-made products when they cross the national border.

The most common type is an import tariff, paid to the destination country by the business importing the goods (or services). Another type is an export tariff, imposed on the products a country exports, hence the name.

However, those are rare—according to the US Constitution (Article I, Section 9), they are prohibited in the United States.

The main point of tariffs is to restrict imports. Simply put, countries use them to bump up the prices of foreign-made products, thus making them less appealing to domestic consumers.

The History of Tariffs

We can trace the history of tariffs all the way back to pre-modern Europe and mercantilism, when colonizers used to implement high tariffs to prevent their colonies from trading with other countries.

Namely, they would import raw materials from their colonies, convert them into manufactured wares, and then sell those back to the colonies. This way, they ensured they stayed competitive with rival colonizers by keeping wealth within their own economies.

In the US, tariffs have been utilized since 1789, when the first major tariff law was enacted to help fund the newly formed nation’s government. However, their importance for the country’s economy changed over time.

For instance, tariffs made up 41% of the US government's income in 1900. A little over a century later, in 2013, that number was much lower—only 2%.

Still, this doesn’t mean that tariffs have lost their purpose in the US economy. Nowadays, instead of raising revenue, they’re implemented temporarily to deal with trade imbalances and protect certain industries.

Types of Tariffs

There are several types of tariffs, each serving a specific purpose.

Let’s look into them more closely:

• Protective tariffs: As the name suggests, these tariffs protect local businesses. They are taxes placed on imported goods, raising their prices and making them less appealing to consumers than domestic products.

• Revenue tariffs: The point of these tariffs is to help a country’s economy. Developing countries use them as a way to make extra money and boost their budget.

• Specific tariffs: These tariffs are fixed at a certain tax rate, charging a specific amount on a product regardless of its cost.

• Ad valorem tariffs: These tariffs are expressed in percentages. Therefore, the more expensive the product, the higher the tariff.

• Compound tariffs: These are the combination of the previous two types. Essentially, they charge a fixed rate plus a percentage of a product’s cost.

• Retaliatory tariffs: These work like payback taxes. In simple terms, if country A places a tariff on country B’s products, country B can respond by imposing a tariff on country A’s products.

• Anti-dumping tariffs: If the exporting country sells its goods way below the market value to crush the competition, the importing country can place this type of tariff to level the playing field.

How Do Tariffs Work?

Answering “What is a tariff?” leads us to another question, “How do tariffs work?”

Regardless of the type, tariffs work by imposing a fee on foreign-made goods or services when they enter the importing country. Whether the fee is fixed, like with the specific tariff, or calculated as a percentage of the imported product’s value, like with the ad valorem tariff, its purpose is to increase the cost of the said product.

Tariffs are collected when the imported goods cross the national border and paid by the importing business. This is done to boost the country’s budget, protect local vendors, or maintain a strong position on the global market.

However, the ones that cover the tariff costs, in addition to importing businesses, are the consumers. Namely, they need to set aside a larger amount of money if they want to buy a foreign-made product.

For example, a car manufacturing company that imports engines for vehicles has a greater production cost due to tariffs. As a result, the cost of its vehicles will go up, directly affecting those purchasing them.

Who Has the Power to Authorize Tariffs in the US?

According to the US Constitution, the power to authorize tariffs is in the hands of Congress. That said, the president can also implement tariffs under specific circumstances, such as economic emergencies or in cases involving national security.

Namely, Congress has given increasingly more control over commerce to the executive branch over the past ninety years. The main reason behind this decision was the introduction of the Smoot-Hawley Tariff Act in 1930, which raised US tariffs to astronomical levels, worsening the Great Depression.

As a result of this power exchange, presidents have been able to lower tariffs and engage in various trade deals, such as the agreement setting up the World Trade Organization (WTO).

Now that we’ve covered what a tariff is, let’s see why governments impose tariffs in the first place.

Why Do Governments Impose Tariffs?

The exact reasons governments impose tariffs vary from economic protection to raising revenue to correcting trade imbalances.

Let’s analyze them in more detail:

#1. Economic Protection

Heavy importing can create serious competition for local industries, so much so that it can damage the country’s economy. Namely, if consumers favor foreign-made products over domestic goods, it puts local manufacturers and vendors at risk of going out of business. They may then shift production abroad or fire workers, leading to higher unemployment rates.

The solution to this problem lies in protective tariffs. The importing country can place them on products crossing its borders to raise their price, giving the edge to its own goods and services.

#2. Raising Revenue

The following forms of taxation are the main sources of a country’s revenue:

• Income tax
• Sales tax
• Corporate tax
• Property tax
• Excise tax
• Value-added tax (VAT)
• Capital gains tax
• Payroll tax

However, they don’t always bring enough money into a country’s budget. This is especially true in underdeveloped countries, primarily because of their underdeveloped industries and high unemployment rates. For these reasons, they tend to rely on imports, implementing revenue tariffs to boost their budget.

#3. Correcting Trade Imbalances

The truth is that international trade is a highly competitive market—newly founded industries are often at a disadvantage against well-established foreign competitors. This is why countries sometimes levy tariffs on imported products in industries in which they want to promote growth.

These tariffs create new employment opportunities within a country while giving “infant industries” a fair chance to develop. Once they’re strong enough to measure up to foreign competitors, the tariffs may be removed.

Pros and Cons of Tariffs

Learning what a tariff is unveils both the pros and cons of this type of taxation.

Let’s see what they are:

2 Recent Examples of Tariffs

The best way to understand a tariff is through examples, so in this section, we will delve deeper into the relatively recent ones that received more media attention.

#1. US-China Trade Tariffs

Tariffs have caused a literal trade war between the US and China.

Namely, President Trump placed heavy tariffs on various goods imported from China during his first term, including semiconductors and electric vehicles. His successor, President Biden, only reinforced these tariffs, adding a few new trade restrictions.

Unsurprisingly, China responded with retaliatory tariffs, targeting industries like energy and agriculture.

#2. EU Steel Tariffs

The European Union has recently extended its tariffs on steel products to protect the domestic steel industry from cheap imports, mainly targeting Asia.

These tariffs were placed in 2018 and renewed in 2024, aiming to stabilize the EU steel market and give local producers a chance to stay on top of the fluctuating global demand.

How Do Tariffs Affect Businesses and Consumers?

Tariffs affect businesses and consumers both positively and negatively. For example, small companies that depend on imported materials can face higher prices and shortages of said materials, which can push them out of business.

Low-income consumers are another group negatively affected by tariffs. These people typically spend a large portion of their earnings on basic necessities, and tariffs can place foreign-made products out of their reach.

On the other hand, newly founded companies with strong overseas competitors can make money thanks to tariffs. With reduced competition, they can stay in business, which also benefits their employees, who can keep their jobs.

An example of an industry reaping financial rewards from implementing tariffs is the US coffee industry.

Final Thoughts

The answer to the “What is a tariff payment?” question is much less simple than it may seem, as tariffs regard everyone—from importing countries and their trading partners to small businesses and consumers.

While tariffs can negatively affect businesses that depend on foreign-made materials and lower-income consumers, they also have many benefits. For example, implementing tariffs protects local producers and vendors, giving them a chance to grow and compete on an international level.

Understanding what a tariff is is crucial for managing business expenses and staying compliant with regulations. For small businesses, tools like Paystub.org help handle financial planning while navigating tariff-related costs.

What is a Tariff FAQ

#1. Are tariffs good or bad?

Whether tariffs are good or bad depends on the point of view. For example, they’re good for newly established businesses seeking to grow. On the other hand, they’re bad for consumers, as they raise the price of foreign products.

#2. Who benefits from tariffs?

The government and “infant industries” benefit most from tariffs.

#3. Can businesses avoid tariffs?

Businesses can avoid tariffs by sourcing materials domestically or negotiating trade deals in tariff-free zones.