What is a tariff, who pays, and why it matters to your business

What are tariffs?

In a nutshell, tariffs are an import duty. As such, they are generally considered part of the cost of goods sold because they are a direct cost associated with buying or producing a product. Most of the time, tariffs are set ad valorem, and are therefore a percentage of the value of an import. But they could also be a specific tariff consisting of a fixed fee per unit of goods (unit, tonne, etc.), or even a combination of the two.

Simple examples here include the “Chicken Tax,” a 25% tariff on light trucks imported into the US that began in 1964 as a retaliatory measure against European tariffs on chicken imports ... and is still in effect to this day. Under the Australian Cheese and Curd Quota Scheme, a tariff quota applies to certain types of cheese with a duty of $0.096 per kilogram up to 11,500 tonnes per year and a higher rate thereafter.

Who can decide on tariffs?

National governments, typically the legislative branch, have the authority to set tariffs to impose on their trading partners. In most cases, they do so for three reasons:

Increase revenue
Since tariffs are duties to be paid when importing a good, this creates a revenue stream for countries that can be used to balance their budget or for public services. According to the Council of the European Union, for example, 13.7% of the EU budget comes from tariffs.

Protect domestic industry
By specifically increasing tariffs on a defined range of products and making it prohibitive to import these goods, governments are essentially protecting the local industry and associated jobs by promoting local production, either through established national actors or through Foreign Direct Investment mechanisms, both resulting in strengthening domestic manufacturing.

Negotiation leverage
When emergency tariffs are imposed, these can be limited in time and used as leverage to encourage concessions from other countries. Once the trading partners have agreed on new terms and any trade imbalance is reduced, tariffs can be removed. This has often been described as a tool of “hardball diplomacy”, and is usually only available to countries already in a commanding position.

International organisations such as the World Trade Organisation can also influence—but not enforce—tariff policies through agreements. With its primary purpose being the promotion of open trade for the benefit of all and trade facilitation, when there are trade disputes such as disagreements between parties on tariffs, member countries can appeal to the World Trade Organisation Dispute Settlement Body. If mediation fails, the Dispute Settlement Body can authorise the winning party to implement retaliatory measures such as trade sanctions.

Who pays tariffs?

It is the importer’s responsibility to determine and pay the correct duty to the customs authorities in the importing country. Any errors in the customs clearance process—for example, incorrect classification of goods, undervaluation, and declaring the wrong country of origin—can lead to delays and even fines and penalties for underpayment or non-payment of tariffs of course, but could also escalate to goods being seized until resolution or even legal actions with lawsuits and criminal charges being brought forward. All actors in the supply chain should also ensure they maintain evidence of origin throughout the end-to-end supply chain as evidence may be required to determine the true origin of goods and to substantiate claims of sufficient transformation.

Nevertheless, to maintain margins, or if absorbing increased costs would jeopardise the overall business sustainability, part or all of the duties can be passed on to customers—either directly to the consumer for wholesale products, or to other companies when the product enters a manufacturing process.

Realising that tariffs could hinder competition and affect end customers with higher prices, governments have collaborated on trade agreements. Sometimes even annulling tariffs for specified products or industries. This has shaped certain sectors that have shifted to an integrated value-added supply chain, making full use of these trade agreements to optimise the manufacturing of products by focusing on areas of expertise and lower costs.

An example here would be the North American automotive sector, where the United States and Canada have historically had a long-standing trade agreement that enables car manufacturers to purchase raw materials in Canada, manufacture car components in the US, then move the components across the border to Canada to enter the manufacturing of a large component and return to the US for an assembly line, all without incurring duties at every crossing.

Long-lasting effects

A pernicious aspect of temporarily imposed tariffs is that they often remain in place long after their intended effect. Much like in the example of the Chicken Tax mentioned earlier. They can also shift to non-tariff barriers if negotiations result in incomplete agreements. Affected industries, therefore, must adapt to a new normal, implement a longer-term mitigation approach, or accept that this creates a new de facto situation—which can once again be rapidly unsettled by changing political factors.

In a growing networked economy where businesses, individuals, and governments are interconnected, protectionism and barriers can have unintended impacts that have yet to be fully uncovered. Flexible planning and agility, enabling companies to react to changing environments, will be of the greatest importance for businesses worldwide.

I would like to thank The Chartered Institute of Export & International Trade for their collaboration on this article.