What is a Tariff?

As you are probably hearing this term thrown around a lot in the news lately, it is important to know what it is. A Tariff is a tax on goods and services that are imported into a country. It can also be known as a duty that needs to be paid on a particular class of imports or exports. Also called a trade barrier.

Why do Tariffs Exist?

There are a few different purposes of tariffs that economists consider. One being, a tariff is designed to protect the product or service that is domestically produced. We will walk through a basic example. Imagine Company A produces Widgets and they make these widgets and everything that is apart of the widget, in California. Then the widgets are sold to consumers in the USA for $10. Then there is Company B who also produces widgets, but they are a company based and manufactured in China. Company B sells their widgets to consumers in the USA for $8, making their widget cheaper than Company A widgets. Well what could happen is the USA could put Tariffs on Company B widgets being imported into the USA, say $4. Now for the consumer in the USA to buy Company B’s widgets, they will have to pay $12. Making it more expensive than the widgets that are made in the USA by Company A.

In the prior example, this is the purpose of protecting local companies with tariffs on imports. If a company is making a product domestically and another country makes that same product and imports it into that country, that country can use tariffs on the product to protect the product domestically made.

Also, a country will attach tariffs to certain imports to protect industries that are essential or that may have strong political influence. Doing so can raise the cost of a certain import and hopefully resulting in a less amount imported of that particular good.

Is a Tariff a good or bad thing?

Creating a tariff or even raising a tariff, is a very slippery slope for a country to embark on. Tariffs can often result in Trade Wars between countries. Trade wars can begin when one country may think that the other country’s trading practices are unfair to them. One thing to note, a Trade War between 2 countries can often lead to other countries being affected, who aren’t directly involved. Another negative to Trade Wars can be that it creates a less of a need for innovation. If the government were to step in to protect a domestic company and apply tariffs on an international competitor to save the domestic company and their business, that is not entirely good for everyone. Doing this, the government has saved the domestic company and doesn’t entirely push them to reach better innovation where if they have done so, the international competitor may not have been taking market share from them and force the government to apply tariffs on the international company.

How are companies and countries avoiding Tariffs?

There are some grey areas of avoiding tariffs that countries will partake in. Note, avoiding tariffs can be illegal. But I found some interesting things that countries will go through to avoid heavy tariffs imposed on their imports into other countries. One of these grey areas is called “Substantial Transformation.” This allows companies to indicate a different company of origin when importing a good to another country. This is often done by a country sending their good to another country and that country will not have tariffs imposed on their imports to the end country the good is being shipped to. Substantial Transformation is production that results in a new and different good. It will then be provided with a new name or character or use or tariff code from what it originally had. Like I said this is a grey area.

Another technique being used is referred to as “Code Fudging.” This is simple, importers are telling customs that a specific product is something similar but different. This sits in a grey zone also. Imagine a country is importing a soccer ball into the USA, they have a soccer ball box for the product and code for a soccer ball, but inside the box is a football. This is code fudging. Every USA import will fall into 1 of 18,927 product categories. So, you can imagine that customs may have a hard time catching every product that is coming through with a code fudging technique.

Another technique, which is similar to the first one I listed, is called “Transshipment.” This process would lead to falsifying origin documents, which is illegal. But is done when a company sends the product on a stop over to another country, which is not the exporting or importing country. Then the company sends the product to the final country, where there are no tariffs on that stop over exporting country. The final technique I will talk about is called “Radical Alternative Relocate.” This is done when tariffs are so heavy against one particular country that it just doesn’t make sense for a company to continue to work out of that country. It makes more sense for that company to go somewhere else to export their goods from. Some companies have moved the final phases of production to 3rd countries where export products can be substantially transformed before being shipped.

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