Tariffs are taxes imposed by one country on goods or services imported from another country. Tariffs are trade barriers that raise prices and reduce available quantities of goods and services for U.S. businesses and consumers.
How do tariffs work?
Tariffs are paid when a good or services is imported into a country. If a car manufacturer imports engines that are then used in vehicles, then tariffs on those imported engines will increase the production cost and the cost to the consumer. The costs of tariffs result in higher burdens on international trade which can harm production.
Many businesses have supply chains that cross multiple borders, and each border that is crossed could result in higher costs due to tariffs.
Who bears the burden of tariffs?
While tariffs are often described as a tax on foreign businesses, the costs are often borne by consumers in the country that is imposing the tariffs. Tariffs directly increase the cost of domestic sales by artificially increasing the price on imports.
The distributional effects of a tariff (the economic burden it places on households across income levels) tend to be regressive, burdening lower-income households more than higher-income households.
Tariffs are taken out of business revenue before it is distributed as compensation to factor inputs (workers and capital). This creates a wedge between what workers and capital produce and the amount they receive; in other words, a wedge between the consumer price and the producer price.
Tariffs ultimately fall on the factors of production and reduce taxpayer labor and capital income. This occurs either by raising prices or reducing wage and capital income. Tariffs tend to be regressive because the average shares of income sources burdened by tariffs are higher for lower-income taxpayers.
Analysis of imposed and threatened U.S. tariffs (as of December 2018) shows that lower and middle-income households experience relatively larger drops in after-tax income.
|Income Percentile||Change in After-Tax Income|
|Lowest Quintile (0% to 20%)||-1.37%|
|Second Quintile (20% to 40%)||-1.32%|
|Middle Quintile (40% to 60%)||-1.37%|
|Fourth Quintile (60% to 80%)||-1.31%|
|Top Quintile (80% to 100%)||-1.14%|
|80% to 90%||-1.25%|
|90% to 95%||-1.24%|
|95% to 99%||-1.18%|
|99% to 100%||-0.95%|
|Source: Tax Foundation Taxes and Growth Model, April 2018|