What are Tariffs – How Do They Work?

Most modern economists suggest that tariffs are harmful for all nations involved and in the last 60 years many countries have been trying to minimise any friction to trade by removing tariffs. However, in recent news, not a day goes without mention of tariffs! So what are tariffs, why is everyone talking about them and how do they affect your day to day business?

A Background into Tariffs

A tariff is essentially a tax on imports and/or exports between sovereign states. Historically, governments have used tariffs to raise funds from traders. It is important to note that tariffs don’t cause a rise in the seller’s price, but instead cause an increase of the purchaser’s cost, affecting importers and consumers. They are often collected by Customs agents at entry points such as seaports, airports or border crossings. The revenue from these collections then goes to the government.

Interestingly the US Federal government was primarily funded through customs revenue from independence until 1913 when the Revenue Act was passed, leading to the introduction of income tax. During this period, customs revenue routinely accounted for 80-90% of total federal revenue. As of 2017 customs revenue makes up roughly 5% of revenue.

Other than revenue generation, tariffs have also been used to provide protection for domestic industries or to attempt to influence global trade. In theory, through tariffs goods imported from overseas end up costing due to the additional taxes placed on these imports. The additional costs end up being borne by consumers. Supporters of tariffs say that they help protect domestic industries that are less competitive. Opponents of tariffs argue that tariffs are an unfair tax on consumers and results in domestic manufacturers less competitive with little incentive to improve production processes.

How tariffs work

Modern Tariffs

The World Trade Organisation (WTO) is where nations negotiate and set the rules on international trade. The WTO deals with diverse matters from the harmonisation of product classifications to the administration of trade rules. Generally no WTO member may discriminate against another member when trading. This is known as most-favoured-nation (MFN) treatment, all WTO members should be given the same tariffs. There are exemptions to this.

The WTO state: “countries can set up a free trade agreement that applies only to goods traded within the group —   discriminating against goods from outside. Or they can give developing countries special access to their markets. Or a country can raise barriers against products that are considered to be traded unfairly from specific countries. And in services, countries are allowed, in limited circumstances, to discriminate. But the agreements only permit these exceptions under strict conditions. In general, MFN means that every time a country lowers a trade barrier or opens up a market, it has to do so for the same goods or services from all its trading partners — whether rich or poor, weak or strong.”

Despite these rules, the WTO do not have any enforcement powers. They can investigate claims brought against sovereign nations for unfair tariff targeting and these findings are then published. If there is no remedial action undertaken, the WTO then allows retaliatory tariffs.  

The WTO are currently investigating the tariffs from the US & China

Issues with Tariffs

The US has increasingly attempted to influence global trade by placed placing tariffs related to the country of origin of a product. Through the Trade Act 1974, the US imposed 25 per cent additional tariffs on approximately $34bn of Chinese imports in June 2018. These have slowly ramped up and almost all goods from China imported to the US now attract a 25% tariff. This has created a large headache for product owners, it isn’t easy to build a new supply chain in less than a year. I wrote about this earlier in a previous post.

Ge-Shen is based in Malaysia where we maintain normal WTO trading tariffs with the US and have extensive experience with localising supply chains. Do get in touch with us to see if we can help you overcome problems associated with new or potential tariffs

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