What is a tariff? An easy to understand definition

If you import goods, you need a good understanding of tariffs for things to be hitch-free. Hence, tariffs impact the eventual cost of imported goods. That is to day, it is necessary to understand how it works.

In this article, we will examine what tariffs are. Also, we will look at how they work, good examples that provide context, and four common types. By the end, you will have a good grasp of this crucial part of importation.

Let's get started.

Definition of tariffs

Tariffs are taxes used to restrict the import of certain goods into a country. In simpler terms, they are prices imposed by a country's government on certain goods imported from another country.

The primary reason for imposing tariffs is to increase the price of certain imported goods to make them less desirable for domestic consumers. Another reason is to make these goods less competitive with domestic goods, thus protecting domestic producers. Consequently, the domestic consumers who purchase these goods will do so at higher prices than they ordinarily would.

How do tariffs work?

As we already mentioned, tariffs function by increasing the price of imported goods to protect the domestic industries of the importing country. However, despite the rationales for imposing tariffs, the act remains a barrier to international trade and business. One reason for this is that other countries sometimes impose their tariffs on imported goods in retaliation.

As of 2018, the average tariff charged by the United States on imported goods was less than 2%¹. However, the tariff rates charged on imported goods differ, as each rate depends on the industry enjoying government protection. For example, a 40% tariff is imposed on all watches being imported to the country. The rationale for this would be to discourage domestic customers from purchasing these imported goods and instead buy from local manufacturers. By the way, countries may impose tariffs as sales tax, extra customs fees, and local taxes. They usually collect them during customs clearance.

Further, some countries have free trade agreements with each other. For this reason, imports and exports between these countries are free and without tariffs. For instance, the U.S. has free trade agreements with 20 countries. Thus, every export and import between the U.S. and these countries do not require the payment of tariffs.

Therefore, many U.S. businesses focus on exporting their goods and services to these countries. In that case, they won't have to pay any tariff that would affect their profits. Likewise, their foreign customers would have to pay less.

Examples of tariffs

The following are examples of U.S. tariffs across three centuries, ranging from the 1800s to the 2000s. They also include some of the advantages and disadvantages of tariff introductions in the country.

The Tariff of Abominations

In the 1820s, the U.S. government imposed a tariff on most imports into the country. The aim was to protect the manufacturers in the Northeast region of the country. Unfortunately, it proved damaging to those in the South. By increasing the price of these imports, two things happened:

1. the cost of most products increased
2. trade with England, the primary consumer of southern U.S. cotton, reduced

And because of the reduction in trade with England, the price of southern U.S. cotton rose, and there was a drop in the income it generated.

The Great Depression

Apart from the above, tariffs also contributed to the Great Depression of 1929. In 1930, the U.S. government introduced the Smoot-Hawley Tariff, which increased the high tariffs on agricultural products. This tariff aimed to provide support to those farmers who had suffered at the hands of the Dust Bowl. Sadly, the increased price of these imported products was damaging to Americans, especially those badly affected by the Great Depression.

This further promoted other countries to impose their tariffs in retaliation. Consequently, there was a huge drop of about 60% in world trade.

The Steel and Aluminum Tariffs

In March 2018, the US government imposed a 10% tariff on aluminum and a 25% tariff on steel. This aimed to create more jobs and facilitate the growth of the steel and aluminum industries. Fortunately, this tariff led to an increased number of jobs in these industries. However, the Congressional Budget Office found that its effect on the economy was negative overall.

Four common types of tariffs

There are four common types of tariffs, and they are:

• Specific tariff
• Ad valorem Tariffs
• Compound tariff, and
• Tariff rate quotas

Specific tariff

Specific tariff describes the fixed amount of money imposed on a physical unit of a product. It does not depend on the value of the imported or exported product; rather, it focuses on its unit (weighted). It is often imposed on goods like wheat, sugar, rice, cement, and clothing. One of the benefits of this tariff is that it is easy to administer. The reason being that the goods do not have to be evaluated.

Determining the value of a traded product is quite difficult, as there are different types of prices. Some of them are demand price, supply price, contract price, market price, invoice price, free on board (F.O.B.) price, cost, insurance, and freight (C.I.F.) price. By focusing on the units rather than the prices, governments can avoid complicating the complexities.

However, certain high-value goods, like T.V. sets, jewelry, cars, artworks, and wristwatches, can't hold specific tariffs. Instead, tariffs are imposed on them based on their surface area, weight, and number.

To illustrate, the United States imposes a tariff of 3.2 cents on each liter of some milk types.

Ad valorem tariff

Ad valorem is Latin for 'on the value.' This tariff type describes taxes that are imposed based on the value of imported goods. It is a fixed percentage of the imported good's value. For a product to qualify for this tariff type, its value must be disproportionately higher than its physical properties, like weight or measurement.

This tariff is considered equitable as it imposes a large tariff rate on expensive products and a low rate on cheap ones. For instance, if imported watches attract a 60% tariff, the more expensive ones with high costs (say $800) will have high tariff rates (like $480), while the cheaper ones will have lower tariffs.

An advantage of this tariff is that it allows for easy comparison of these goods' international prices.

Compound tariff

As the name suggests, the compound tariff combines two types of tariffs: the specific tariff and the ad valorem tariff. As such, it imposes taxes based on both the unit and value of a product. A good advantage of this tariff type is that it enables the generation of greater revenue to the nation. It also offers more effective protection to industries involved in domestic production.

Tariff rate quotas

The tariff-rate quota type combines two trade policies: tariff and quotas. It functions by imposing a fixed amount on imported goods of a particular quantity. For example, the tariff on milk might be 3.5 cents per liter on 1,000 units. However, if the amount of milk imported exceeds 1,000 units, the tariff would increase to 6 cents per liter.

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By the way, if you will be doing customs clearance for your products yourself, this article will guide you.