Tariffs Explained: Their Purpose and Inner Workings

Let’s return to fundamentals. What exactly is a tariff, what part do tariffs play in the economy, and how have they been implemented, throughout history and today?

The big picture: Once the main method for collecting tax revenue, tariffs have been largely abandoned by both elected officials and economists due to their numerous drawbacks.

President Trump aims to overturn that longstanding trend.

The basics: A tariff is a levy imposed on products that come from outside the country. If a vessel carrying bananas, T-shirts, or Toyotas docks at a U.S. harbor, one of the requirements for clearing customs involves settling the relevant tariff, which can also be referred to as an import duty.

In recent times, these taxes have dropped significantly—falling to 1.5% in 2017 following many years of collaborative work across political parties aimed at developing international trade agreements.
President Trump subsequently raised them to approximately 3% during his earlier tenure (a level largely upheld by President Biden).
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 period up until the early 1900s, tariffs served as the main source of revenue. predominant source from the federal government's income.

Import taxes were fairly straightforward to monitor even back when we lacked computers, social security numbers, and similar tools. Upon arrival of a vessel at a harbor, customs officials had the capability to examine the cargo, apply the relevant tariffs, and verify adherence to taxation regulations.
The Constitution restricted the federal government's power to levy taxes, making a contemporary income tax unconstitutional until the adoption of the 16th Amendment in 1913.
Lawmakers aimed to shield local industries from European rivals as these industries developed. (This mirrors strategies employed by Japan and South Korea during the second half of the 20th century when they utilized protective measures to help their nations close the gap with leading global economies.)

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 harmed agricultural sectors and other American exporters, since various nations established similar trade obstacles.
The tax load mainly affected individuals with lower incomes, as they dedicate a larger portion of their funds to essentials compared to wealthier citizens.
They failed to gather anywhere near sufficient funds to cover the expenses of a contemporary administration, including a substantial armed forces, various social safety nets such as Social Security and Medicare, among others.
During the peak of America's period focused on tariffs, revenues stood at approximately 1.1% of GDP. Nowadays, government expenditures amount to roughly 23% of GDP.

Moreover, They skewed economic activities. Leading American sectors invested more time lobbying for special favors through tariffs rather than focusing on crafting superior goods capable of thriving globally.

In 1930, when the global economy faltered, countries quickly introduced tariffs with the aim of supporting their local industries, notably through measures like the Smoot-Hawley Tariff Act in the United States. According to mainstream economists, this wave of protective policies was largely responsible for transforming that economic crisis into what we now know as the Great Depression.
Drawing from these lessons and as part of an extensive initiative aimed at integrating the economies of democratic countries worldwide with the hope of fostering enduring peace, the U.S. along with other developed nations dedicated the post-war period to progressively eliminating tariffs and dismantling trade obstacles.

Reality check: During the peak of free trade optimism, tariffs didn’t drop to zero.

In certain instances, it might be quite straightforward. realpolitik, For instance, when President Bush increased steel tariffs in 2002 in an attempt to gain backing from states with significant steel industries.
Farmers hold significant political influence and have traditionally managed to obtain substantial import duties on various food items such as dairy products and sugar.
Pro-trade economists might agree with certain restricted tariff measures, like safeguarding and fostering domestic sectors considered vital for national defense.

Zoom out: During his initial term, Trump utilized clauses within trade legislation that grant the president the power to unilaterally impose tariffs on particular nations and goods based on purported national security concerns or as a response to unjust trading tactics.

These were implemented with strict legal boundaries along with a procedure for businesses to request exemptions—moreover, their cumulative impact was not significant enough to alter the broader U.S. economic landscape substantially.
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: Should the newly introduced tariffs remain in place, Americans would face an average tax burden on imports not witnessed since almost anyone alive today was born. This level surpasses those during the Smoot-Hawley period and places them near the rates of 1909.