Takeaways
- Tariffs are taxes on goods and materials imported from other countries.
- Tariffs generally fall into two categories: fixed-price or ad-valorem tariffs.
- Tariffs generate revenues for governments and protect domestic production.
- Tariffs are tools to spur consumer consumption of domestic goods and materials.
- Leading world economies use tariffs to incentivize goods production, exert political influence, and encourage specialization.
What Is a Tariff?
A tariff is a tax levied by governments on imported products and materials. Governments primarily levy tariffs to raise revenues and foster the development of domestic industries.
Due to inherent natural resource distribution, countries conduct international trade to import goods and materials they need from foreign countries. Free trade flow allows countries to create trading partners to obtain the goods and materials their country needs.
International trade tends to lead to specialization, and countries focus on producing the goods or materials that give them the most trading value. When governments or trading partners disagree or want to develop domestic capabilities, they may impose tariffs on imported goods.
Tariffs increase the cost of goods and materials for businesses and consumers, leading to rising prices. Consumer behavior oscillates with changing tariffs.
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How Tariffs Work
Tariffs are used to limit imports. Because they are taxes on goods, they increase the prices of foreign products. As the prices of materials and goods increase, consumers adjust their spending patterns accordingly and favor less expensive domestic products.
It is important to note that tariffs affect exporting countries, driving down product demand. Governments may impose tariffs to generate needed revenue (to pay the national debt), ensure the production of certain goods domestically (e.g., critical pharmaceutical drugs), or spur political discourse (bring multiple trading partners together to negotiate better trading terms).
Tariffs can sometimes lead to unattended market consequences. If households face rising costs, consumer debt can increase as people struggle to maintain a similar lifestyle.
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Types of Tariffs
There are many types of tariffs imposed on governments around the world. Here are four often used-tariff structures:
- Flat-fee tariffs are imposed on specific types of products at a set dollar amount. For example, the U.S. could levy a $600 flat-fee tariff on all imported foreign cars.
- Ad-valorem tariffs are calculated based on a percentage of the value of a good or material. Percentages can vary depending on the specific good and industry. Higher ad-valorem tariffs tend to be applied to goods competing with coveted domestic products.
- Volume-based tariffs vary in complexity. Governments sometimes issue tiered volume-based structures. Low-volume imports face a smaller percentage, say 2%. However, once imports exceed a minimum import level, the percentage increases to 3% or 4%.
- Combination tariffs use flat fees, percentages, and volume-based structures. A country could add a combination of tariffs to imports depending on its desire to encourage domestic consumption over imports.
Pros of Tariffs
- Increase Revenues: Tariffs allow the government to make money on imports. They can spend this revenue on new government programs, balance the budget, or foster tax incentives for domestic production. In a recent Congressional Budget Office projection, the CBO estimated that tariff revenues would yield $872 billion from 2025 through 2034. This estimate does not take into effect the impacts of the 2025 Trump Administration tariffs.[1]
- Saving Jobs and Shielding Industries: Economic tools like trade and tariff negotiations can help save domestic jobs and form a protective moat around coveted industries. By placing super high tariffs on imported goods and materials, consumers look for less expensive options. Domestic goods, with less regulation, can strategically fill that consumer need.
- Increase National Security: Tariffs can act as an economic boycott. Governments can impose tariffs to weaken opponents economically, bring countries to the negotiating table, or force political will. For example, the Trump Administration wanted neighboring countries to better control the flow of drugs, including fentanyl, across American borders. As a result, the U.S. imposed 25% tariffs on Mexico and China.[2]
- Protect Consumers: Regulation isn't always bad, and tariffs can be used to adjust consumer behavior. Tariffs can be placed on goods with unhealthy side effects or without good manufacturing practices. These tariffs are designed to protect consumers and force international countries to make healthier and safer products.
- Impose Political Leverage: The United States has many economic tools in its toolkit, ranging from the federal funds rate to the strength of the U.S. dollar to tariff policy. Tariffs are used to bring countries into negotiations, raise political concerns, or start cross-border trade partnerships.
Cons of Tariffs
- Trade Wars: Starting a trade war with another country can be an unintended consequence of implementing tariffs. A trade war is an economic conflict between two countries. They lead to rising tariffs, quotas, protectionism, and decreasing trade.[3]
- Cross-Border Tension: Tariffs can be used as a retaliatory tactic to express disapproval of another country’s trade or domestic policies. While tariffs can be used as a negotiating chip, they can also catalyze rising tensions between nations.
- Increasing Prices: Domestic companies might temporarily benefit from a surge in demand due to higher prices on imported competing products. However, if the domestic industry is too far behind in production or capacity, this could lead to higher prices caused by scarcity of domestic products. Unfortunately, this could raise consumer prices, whether you are consuming foreign or domestically produced products. (Read more about 5 Ways to Curb Overspending).
Who Pays for Tariffs?
Businesses importing products, materials, and goods pay the tariff tax. Ultimately, this increases their purchase price and input costs. Companies then pass this increased cost on to consumers, who bear the brunt of rising tariffs.
Absorbing tariff increases affects all levels of the economy. Even high earners feel the impact of rising tariffs, which boost the price of everything from foreign luxury cars to maple syrup.
Read More: How to Shop and Save Money Even with Tariffs
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How Tariffs Affect the Stock Market
Higher tariffs mean higher prices on imported goods, which could be bad news for companies that rely on imported parts, materials, or products.
Publicly traded companies forecast revenues and expenses and provide financial guidance to investors, analysts, and financial media. Institutional investors also conduct their research and form economic models to predict a company’s valuation.
If unexpected tariffs suddenly increase the price of a company's critical ingredient and the business cannot pass that cost along to consumers, the company's profit margin will start to recede. Investors will sell the stock because of less projected revenue for a better-performing asset. Poor-performing stocks will erode confidence in a sector, and investors can shift their focus out of a particular stock market segment and start investing in another type of asset class.
Smart Summary
Tariffs are taxes levied on imported materials, products, and goods. They can raise government revenues, be used for political bargaining, spur domestic production or consumption, and establish equivalency between trade partners. Tariffs between trading partners have been used for hundreds of years and are an economic tool governments use when necessary. When used in the right way, they can be a positive force for international negotiations and trade.
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(1) Congressional Budget Office. How CBO Projects Tariff Revenues. Last Accessed March 18, 2025.
(2) Associated Press. Trump says he’ll place tariffs on Canada, Mexico and China on Saturday. Last Accessed March 18, 2025.
(3) Cambridge. Trade War. Last Accessed March 18, 2025.
