A tariff (sometimes known as a customs duty) is a tax on imported or exported goods. A revenue tariff is set with the intent of raising money for the government. A protective tariff, usually applied to imported goods, is intended to artificially inflate prices of imports and "protect" domestic industries from foreign competition (see also Effective rate of protection). The distinction between protective and revenue tariffs is moot; revenue tariffs offer protection, and protective tariffs produce some revenue unless they are prohibitive in which case little or nothing is imported of that product, thus resulting in trivial or no revenue.
Tariffs are similar to tolls, which are applied to people rather than goods.
Tax, tariff and trade rules in modern times are usually set together because of their common impact on Industrial policy, Investment policy and Agricultural policy. A Trade bloc is a group of allied countries agreeing to minimize or eliminate tariffs against trade with each other, and possibly to impose protective tariffs on imports from outside the bloc. A Customs union has a common external tariff, and, according to an agreed formula, the participating countries share the revenues from tariffs on goods entering the customs union.
If a country's major industries lose to foreign competition, the loss of jobs and tax revenue can severely impair parts of that country's economy. Protective tariffs have been used as a measure against this possibility. However, protective tariffs have disadvantages as well. The most notable is that they increase the price of the good subject to the tariff, disadvantaging consumers of that good or manufacturers who use that good to produce something else: for example a tariff on food can increase Poverty, while a tariff on steel can make automobile manufacture less competitive. They can also backfire if countries whose trade is disadvantaged by the tariff impose tariffs of their own, resulting in a Trade war and disadvantaging both sides.
There are two mains ways of implementing a tariff:
Adherents of Supply-side economics sometimes refer to domestic taxes, such as income taxes, as being a tariff affecting inter-household trade.
As a result of this price differential we see that domestic consumers will import these cheaper international alternatives, while decreasing consumption of domestic made produce. This reduction in domestic production is equal to Y* minus Y1, thus reducing producer surplus from the area A, B and L to C, D and L. This shows that producers are unambiguously worse off with the introduction of international trade. One the other hand we see that consumers are now paying a lower price for the goods, which increases the consumer surplus from the area A, B and K to a new surplus of F, J and K. From this increase in consumer surplus we see that some of this surplus was, in fact, redistributed from producer surplus, equal to the area A, B, F and G. However, the net societal gains from trade, in terms of net surplus, are equal to the area B, G and J. The level of consumption has increased from Y* to Y2, while imports are now equal to Y2 minus Y1.
Let’s say we now introduce a tariff of $10/unit on imports. This has the effect of shifting the world supply curve vertically by $10 to SW + Tariff. Again, this will create a redistribution of surplus within the model. We see that consumer surplus will decrease to the area C, E and K, which is a net loss of the area C, E, F and J. This now makes consumers unambiguously worse off than under a Free trade regime, but still better off than under a system without trade. Producer surplus has increased, as they are now receiving an extra $10 per sale, to the area C, D and L. This is a net gain of the area C, D, F and G. With this increase in price the level of domestic production has increased from Y1 to Y3, while the level of imports has reduced to Y4 minus Y3.
The government also receives an increase in revenues as a result of the tariff equal to the area D, E, H and I. In dollar terms this figure is essentially $10*(Y4-Y3). However, with this redistribution of surplus we do see that some of the redistributed consumer surplus is lost. This loss of surplus is known as a Deadweight loss, and is essentially the loss to society from the introduction of the tariff. This area is equal to both the areas D, G and H and also E, I and J. It is because of this loss to society, through the inefficient redistribution of surpluses, which creates a Market failure.
Some proponents of Protectionism claim that imposing tariffs that help protect newly founded infant industries allows those domestic industries to grow and become self sufficient within the international economy once they reach a reasonable size.
The second issue was the political dimension of the tariff. From the 1790s to the 2000s, the tariff (and closely related issues such as import quotas and trade treaties) have generated enormous political stresses. At one point South Carolina threatened to break up the Union on the tariff issue. Historians and economists have always been perplexed, because every analysis of the real economic impact of tariffs has shown their effect to be rather small on the economy as a whole, of minor importance to the economies of different regions, and of substantial importance to only a handful of industries (especially wool and automobiles).
The Tariff Act of 1789 was a key stage in breaking away from Britain and creating a unified, fully independent nation. The new Constitution allowed only the federal government to levy tariffs, so the old system of state rates disappeared. The new law taxed all imports at rates from 5 to 15 percent. These modest rates were primarily designed to generate revenue to pay the national debt and annual expenses of the federal government. Treasury Secretary Alexander Hamilton proposed a far-reaching scheme to use protective tariffs as a lever for rapid industrialization, but his proposals were ignored until 1816. Likewise owners of the small new factories that were springing up in the northeast to produce boots, hats, candles, nails and other common items failed to obtain higher tariffs that would significantly protect them from more efficient British producers. A 10% discount on the tax was offered on items imported in American ships, advice designed to help the carrying trade. Members of Congress proved keenly interested in supporting their local interest by suitable amendments to tweak the schedules, a pattern that would never end.
After the War of 1812, tariffs were raised sharply. Hatred of England was one reason; the primary goal was protection for the manufacturing industries that now were growing rapidly in the Northeast. Every Congressman was eager to logroll a higher rate for his local industry. Senator Daniel Webster, formerly a spokesperson for Boston's merchants who imported goods (and wanted low tariffs), switched dramatically to represent the manufacturing interests in the Tariff of 1824. Rates were especially high for bolts of cloth and for bar iron, of which Britain was a low-cost producer. The culmination came in the Tariff of 1828, ridiculed by free traders as the "Tariff of Abominations", with duties averaging over 50 percent. Intense political reaction came from South Carolinians, who concluded that they would pay more for imports and sell less cotton abroad, so their economic interest was being unfairly injured. They attempted to "nullify" the federal tariff and spoke of secession. The compromise that ended the crisis included a lowering of the tariff.
Henry Clay and his Whig Party, envisioning a rapid modernization based on highly productive factories, sought a high tariff. Their key argument was that startup factories, or "infant industries," would at first be less efficient than European (British) producers. We needed high tariffs so they could charge higher prices until they matured. Furthermore, American factory workers would be paid higher wages than their European competitors. The arguments proved highly persuasive in industrial districts. Those districts were not populous enough to outweigh rural America, however, so the Democrats controlled tariff policy, giving the Walker tariff of 1846. they sought minimal levels of a "tariff for revenue only" that would pay the cost of government but not show favoritism to one section or economic sector at the expense of another. Rates fell steadily, bottoming out in the Tariff of 1857 at 18 percent in 1861. The Canadian-American Reciprocity Treaty increased trade between 1855 and its ending in 1866.
During the Civil War the federal government needed vast revenues. The result was the Morrill tariff of 1861. Desperate for money, the new Confederate States of America imposed the 1857 tariff rates on all trade with the United States--replacing of course the free-trade pattern among the states. This would have been the greatest tax increase in American history, but very few people ever paid the Confederate tariff. With the low-tariff southerners gone, the Republican-controlled Congress doubled and tripled the rates on European goods, which topped out at 49 percent in 1868. The U.S. never put a tariff on goods from the Confederacy because the U.S.A. never recognized the legal existence of the C.S.A.
After the Civil war, high tariffs remained. Advocates insisted that tariffs brought prosperity to the nation as a whole and no one was really injured. As industrialization proceeded apace throughout the Northeast, some Democrats, especially Pennsylvanians, became high tariff advocates. The Republican high tariff advocates appealed to farmers with the theme that high-wage factory workers would pay premium prices for foodstuffs. This was the "home market" idea, and it won over most farmers in the Northeast, but it had little relevance to the southern and western farmers who exported most of their cotton, tobacco and wheat. In the late 1860s the wool manufacturers (based near Boston and Philadelphia) formed the first national lobby, and cut deals with wool-growing farmers in several states. Their challenge was that fastidious wool producers in Britain and Australia marketed a higher quality fleece than the careless Americans, and that British manufacturers had costs as low as the American mills. The result was a wool tariff that helped the farmers by a high rate on imported wool--a tariff the American manufacturers had to pay--together with a high tariff on finished woollens and worsted goods. Apart from wool and woolens, American industry and agriculture --and industrial workers--had become the most efficient in the world by the 1880s. They were not at risk from cheap imports. No other country had the industrial capacity, the high efficiency and low costs, or the complex distribution system needed to compete in the vast American market. Indeed, it was the British who watched in stunned horror as cheaper American products flooded their home islands. Wailed the London Daily Mail in 1900, "We have lost to the American manufacturer electrical machinery, locomotives, steel rails, sugar-producing and agricultural machinery, and latterly even stationary engines, the pride and backbone of the British engineering industry."
Nevertheless American manufacturers and workers demanded the high tariff be maintained. The tariff represented a complex balance of forces. Railroads, for example, consumed vast quantities of steel. To the extent tariffs raised steel prices, they felt injured. The Republicans became masters of negotiating exceedingly complex arrangements so that inside each of their congressional districts there were more satisfied "winners" than disgruntled "losers." The tariff after 1880 was an ideological relic with no economic rationale--it was a timebomb waiting to explode--and it repeatedly did explode.
Democratic president Grover Cleveland redefined the issue in 1887, with his stunning attack on the tariff as inherently corrupt, opposed to true republicanism, and inefficient to boot: "When we consider that the theory of our institutions guarantees to every citizen the full enjoyment of all the fruits of his industry and enterprise... it is plain that the exaction of more than [minimal taxes] is indefensible extortion and a culpable betrayal of American fairness and justice." The election of 1888 was fought primarily over the tariff issue, and Cleveland lost. Republican Congressman William McKinley argued, "Free foreign trade gives our money, our manufactures, and our markets to other nations to the injury of our labor, our tradespeople, and our farmers. Protection keeps money, markets, and manufactures at home for the benefit of our own people." Democrats campaigned energetically against the high McKinley tariff of 1890, and scored sweeping gains that year; they restored Cleveland to the White House in 1892. The severe depression that started in 1893 destroyed the Democratic party. Cleveland insisted on a much lower tariff. His problem was that Democratic electoral successes had brought in Democratic congressmen from industrial districts who were willing to raise rates to benefit their districts. The Wilson-Gorman tariff of 1894 did lower overall rates from 50 percent to 42 percent, but contained so many concessions to protectionism that Cleveland refused to sign it. McKinley campaigned heavily in 1896 on the tariff as a positive solution to depression. Promising protection and prosperity to every economic sector, he won a smashing victory. The Republicans rushed through the Dingley tariff in 1897, boosting rates back to the 50 percent level. Democrats responded that the high rates created "trusts" (monopolies) and led to higher consumer prices. McKinley won reelection by an even bigger landslide and started talking about a post-tariff era of reciprocal trade agreements. Reciprocity went nowhere; McKinley's vision was a half century too early.
The delicate balance flew apart on president Taft's watch. Taft campaigned in 1908 for tariff "reform," which everyone assumed meant lower rates. The House lowered rates with the Payne Bill, then sent it to the Senate where Nelson Wilmarth Aldrich worked his sleight of hand. Whereas Aldrich was a New England businessman and a master of the complexities of the tariff, the Midwestern Republican insurgents were rhetoricians and lawyers who distrusted the special interests and assumed the tariff was sheer robbery for the benefit of fat cats at the expense of the ordinary consumer. Rural America believed that its superior morality deserved special protection, while the dastardly immorality of the trusts--and cities generally--merited financial punishment. Aldrich baited them. Did the insurgents want lower tariffs? His wickedly clever Payne-Aldrich Tariff Act of 1909 lowered the protection on Midwestern farm products, while raising rates favorable to his Northeast.
Efforts to restore free trade with Canada collapsed when Canada rejected a proposed reciprocity treaty in fear of American imperialism in the Canadian federal election, 1911. Taft negotiated a reciprocity agreement with Canada, that had the effect of sharply lowering tariffs. Democrats supported the plan but Midwestern Republicans bitterly opposed it. Barnstorming the country for his agreement, Taft undiplomatically pointed to the inevitable integration of the North American economy, and suggested that Canada should come to a "parting of the ways" with Britain. Canada's Conservative Party now had an issue to regain power; after a surge of pro-imperial anti-Americanism, the Conservatives won. Ottawa rejected reciprocity and turned its economy more toward London. The Payne Aldrich Tariff of 1909 actually changed little and had slight economic impact one way or the other, but the political impact was enormous. The insurgents felt tricked and defeated and swore vengeance against Wall Street and its minions Taft and Aldrich. The insurgency led to a fatal split down the middle in 1912 as the GOP lost its balance wheel.
American industry and labor prospered after World War II, but hard times set in after 1970. For the first time there was stiff competition from low-cost producers around the globe. Many rust belt industries faded or collapsed, especially the manufacture of Steel, TV sets, shoes, toys, textiles and clothing. Volkswagen and Honda threatened the giant automobile industry. In the late 1970s Detroit and the auto workers union combined to fight for protection. They obtained not high tariffs, but import quotas. Quotas were two-country diplomatic agreements that had the same protective effect as high tariffs, but did not invite retaliation from third countries. By limiting the number of Japanese automobiles that could be imported, for example, quotas forced consumers to buy American cars, and allowed both the American and the Japanese car companies to raise prices and keep wages and profits high.
The GOP under Ronald Reagan and George H.W. Bush abandoned the protectionist ideology, and came out against quotas and in favor of the GATT/WTO policy of minimal economic barriers to global trade. Free trade with Canada came about as a result of the Canada-U.S. Free Trade Agreement of 1987, which led in 1994 to The North American Free Trade Agreement, NAFTA. It was based on George H. W. Bush's plan to enlarge the scope of the market for American firms to include Canada and Mexico. US President Bill Clinton, with strong Republican support, pushed NAFTA through Congress over the vehement objection of labor unions. Likewise in 2000 he worked with Republicans to give China entry into WTO and "most favored nation" trading status (i.e., low tariffs). NAFTA and WTO advocates promoted an optimistic vision of the future, with prosperity to be based on intellectuals skills and managerial know-how more than on routine hand labor. They promised that free trade meant lower prices for consumers. It also meant lower wages and fewer jobs in older industries that could no longer compete. Opposition to liberalized trade came increasingly from labor unions, but their shrinking size and diminished political clout repeatedly left them on the losing side.