A tariff is a tax levied on a particular foreign product entering a country.

Earlier this month, President Trump escalated his trade war with China by announcing 10 percent tariffs on an additional $200 billion in Chinese imports—which took effect yesterday. But he showed a troubling lack of understanding about how the levies work. Pointing to earlier import duties he imposed, Trump bragged that “China is paying us billions of dollars in tariffs.” Treasury, he added, is collecting “tremendous amounts of money, which is great for our country.”

Where to begin?

What is a tariff?

A tariff is a tax on imported goods. Despite what the President says, it is almost always paid directly by the importer (usually a domestic firm), and never by the exporting country. Thus, if the US imposes a tariff on Chinese televisions, the duty is paid to the US Customs and Border Protection Service at the border by a US broker representing a US importer, say, Costco.

The Chinese government pays nothing, just as the US government pays no tax to Canada for that nation’s tariffs on imported dairy products.  Rather, an importer or supplier for a Canadian supermarket pays the duty on Wisconsin cheese that lands in the grocer’s dairy counter (though I suspect few Canadian retailers are selling much US cheese these days, given the recent unpleasantness between the two countries).

Who actually pays the tariff?

OK, so the importer remits the tariff to its nation’s customs service, but who really pays the tax on imported goods? The answer, I am sorry to say is, it depends.

A business will, if it can, pass its higher after-tax costs on to consumers. Thus, the price of Chinese TVs sold in the US may rise rapidly. But the firms selling those TVs eventually will face competition from companies that sell lower-cost TVs made in a third country that is not subject to the import tax. In that case, some of the tax may be paid by the firm’s shareholders in the form of lower profits or by its workers in the form of lower compensation.

Or, the firm may switch to a non-Chinese supplier and, in effect, nobody will pay the tariff. Still, demand for imported goods subject to the tax won’t go to zero right away—so the government will collect some revenue from the import tax. That’s what the president was bragging about.

Adam Smith explains.

There is lots of economic theory about the effect of tariffs on consumption and prices. After all, tariffs are hardly new and economists since Adam Smith have been writing about their problems  for centuries.

In the short run, higher prices for imported goods will reduce consumption of those goods. But in the longer term, the decline in competition from foreign products makes domestic firms less efficient. And less competition will result in higher prices, not just for those goods subject to the tariff but for competing goods that are not—such as those made domestically. In the case of Trump’s tariffs on China, that means US consumers will pay somewhat higher prices. Thus, not only will the price of Chinese TVs rise, but so will the price of Mexican TVs and US-made TVs (yes, there still are a few).

In the case of Trump’s tariffs, US prices will rise but not by much and US demand will decline but not by much. Chinese exports to the US will fall but most likely be replaced by imports from producers of competing products in other countries.      

Will Trump’s new tariffs generate a big boost in federal revenue?

The short answer is: No.  

Import taxes are a trivial share of federal revenue and, even with Trump’s new tariffs, they will remain insignificant. The president says the US has collected about $22 billion since his first round of tariffs earlier this year. That may be high. But even if it isn’t, keep in mind that the government expects to collect $2.4 trillion in tax revenue in 2018--making $22 billion loose change in the fiscal sofa cushions.

Worse, the new revenue is likely to be temporary as US importers and sellers find suppliers not subject to the tariff. Unfortunately, the tax on consumers in the form of those higher prices is less likely to disappear. 

Once, tariffs were an important source of federal taxes. Before the civil war, they represented nearly 90 percent of federal revenue. But that share fell as the US began exporting many of its own goods overseas and began to reach agreements with importing countries to reduce their tariffs on American products.

By 1915, less than one-third of federal revenue came from customs duties. Increasingly, revenue was collected from the modern income tax that had been enacted just a few years earlier. After World War II, tariffs become a tiny source of US tax revenue. In 2016, import duties made up only about 1 percent of tax collections. Worldwide, tariffs represent only about 3.5 percent of government revenue.

There may be other fiscal effects for the US, however. A substantial decline in Chinese exports to the US will drive down the value of the Chinese currency. That will offset some of the after-tax price of Chinese-made goods in the US. But any lost exports still mean China will collect fewer US dollars and thus buy fewer Treasury securities. That, in turn, will tend to drive up interest rates in the US.

So at the margin at least, taxing imports will drive up prices for US consumers and eventually may raise borrowing costs. Future effects are hard to predict, but no, Mr. President, China is not paying the US billions of dollars in tariffs. Not any more than Mexico is paying for that wall.

Is a tax levied on a particular foreign product entering a country?

What is the tariff?

What is the main purpose of a tariff?

What is tariff in international trade?