Tariffs 101: What they are and how they work
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Let's go back to basics. What is a tariff, what role do they play in the economy, and how have they been applied, both historically and now?
The big picture: Tariffs were once the primary way the United States collected tax revenue, but over time elected leaders and economists alike have rejected them for their many downsides. President Trump is seeking to reverse that long tide.
The basics: A tariff is a tax on imported goods. When a ship full of bananas or T-shirts or Toyotas arrives at a U.S. port, part of the paperwork for crossing the border is paying the applicable tariff, also known as an import duty.
- In recent years, those taxes have been relatively low — down to 1.5% in 2017, after decades of bipartisan efforts to craft global trade deals.
- President Trump then pushed those upward to around 3% in his previous term (which President Biden mostly maintained).
- The policies announced so far in Trump's current term are on track to push the average tariff to 22.5%, per the Yale Budget Lab.
Flashback: From the colonial era through the early 1900s, tariffs were the predominant source of the federal government's revenue.
- Taxes on imports were relatively easy to enforce even in the days before computers, Social Security numbers, and the like. When a ship arrived at a port, customs officers could inspect the goods, charge the appropriate tariff, and ensure tax compliance.
- The Constitution limited the federal government's taxing authority, so that a modern income tax was not legally permissible until the enactment of the 16th Amendment in 1913.
- Politicians sought to protect domestic industry from European competition as it matured. (There are echoes in how Japan and South Korea used protectionist policies in the latter half of the 20th century to allow their countries to catch up to world leaders).
Yes, but: This reliance on tariffs had deep-seated problems, which is why their use has been mostly in retreat over the last century.
- They disadvantaged agricultural interests and other U.S. exporters, as other countries put in place corresponding barriers to trade.
- The tax burden disproportionately fell on lower-income people, who spend a bigger share of their money on basics than the rich.
- They didn't raise nearly enough money to pay for a modern government, with a large military, social welfare programs like Social Security and Medicare, and the like.
- At the heyday of America's tariff-centric era, they raised revenue around 1.1% of GDP. Government spending is now around 23% of GDP.
Moreover, they distorted economic activity. Major U.S. industries spent more effort trying to lobby for preferential treatment via tariffs than they did building great products that could compete on the world stage.
- When the world economy stumbled in 1930, nations rushed to implement tariffs in hopes of bolstering domestic industry, particularly the Smoot-Hawley Act in the U.S. Mainstream economists view this cascade of protectionism as a key part of why that episode became the Great Depression.
- Based on those lessons, and as part of a broader effort to knit together the economies of the world's democracies in hopes of ensuring lasting peace, the U.S. and other advanced nations spent the postwar era gradually removing tariffs and other trade barriers.
Reality check: Even in the heyday of free trade enthusiasm, tariffs did not move to zero.
- In some cases, it's a simple matter of realpolitik, such as when President Bush raised steel tariffs in 2002 to try to bolster support in steel-producing states.
- Agricultural interests exert major political sway and have historically secured high tariffs on imported foods including dairy and sugar.
- There are cases for limited tariffs that even pro-trade economists can live with, such as protecting and nurturing domestic industries seen as important for national security.
Zoom out: In his first term, Trump used provisions of trade laws that allow a president unilateral authority to implement tariffs on specific countries and products on national security grounds, or in retaliation for unfair practices.
- Those came with careful legal limitations and a process for companies to seek exclusions — and their total scale wasn't enough to have much effect on the overall U.S. economy
- This time is different. Trump is implementing tariffs on a scale an order of magnitude higher, on every country on earth and nearly all goods, and by invoking an emergency authority never used for this purpose.
The bottom line: If the new tariffs announced this week stand, America's average tariff burden will be higher than nearly any living human has seen— higher than they were in the Smoot-Hawley era and roughly at 1909 levels.
- That's why markets have reacted so furiously to the president's announcements.
