Tariffs

Introduction

International trade is a two-way street in which countries exchange exports of some of its goods and services for imports of those from another country. By and large, no country exports without importing or imports without exporting. Export and imports, outside the United States and even historically for the United States, roughly match each other. (The United States today is somewhat of an exception because the dollar is the world’s reserve currency and foreign demand for dollar-denominated assets is high: roughly speaking, for every $1 we pay for imports, other countries buy $0.75 of exports, and $0.25 is invested in U.S. assets.)

A country that wants to tax trade can tax exports or imports or both. Export taxes are rare but some countries, usually those with large natural resource exports, use them. For example, oil exporting nations implicitly tax or control oil exports, for reasons to be discussed below, and Argentina has often taxed its soybean and wheat exports. In the United States, export taxes are forbidden under the U.S. Constitution.

While most countries do not tax exports, almost all impose taxes on imports. Any foreign good that passes through a port of entry, either by land, sea, or air, is subject to customs inspection and the payment of duties in order to be admitted into the country. Some countries, such as Chile, levy a uniform flat tariff on all imports (6 percent in Chile’s case). But most countries have widely different tariff rates on thousands of products, from apparel to steel to fish to minerals. At the same time, an importing country sometimes does not put a tariff on goods that it does not produce. For example, the United States does not tax imports of bananas and coffee, which are not produced at home.

Why Do Countries Impose Tariffs?

Why do countries impose tariffs on imports? For the United States, as with most countries, there have been three main rationales for doing so: revenue, restriction, and reciprocity.1

Revenue

Governments require revenue to function. Before governments had the ability to impose income taxes or consumption taxes, they found it convenient to levy taxes on foreign trade, especially imports. One of the first pieces of legislation that the U.S. Congress enacted under the new constitution in 1789 was an import tariff. A tariff was an efficient tax in the sense that, back then, the United States was an agrarian society, and all foreign goods had to enter the United States through a few major ports on the eastern seaboard of the country, such as Boston, New York, Philadelphia, Baltimore, and Charleston. Sales or excises taxes were much more costly to enforce throughout the United States and politically controversial as well. (President George Washington called out federal troops to quell the Whiskey Rebellion in Western Pennsylvania, a rebellion that grew out of taxes on alcohol.)

Prior to the Civil War, import tariffs raised about 90 percent of the federal government’s revenue. (Of course, federal spending was only about 2 percent of Gross domestic product (GDP), making it feasible to fund the government almost exclusively by customs revenue.) After the war, other domestic taxes were introduced and the share of government revenue coming from tariffs fell to about 50 percent. Once the income tax was introduced in 1913, the share of federal revenue raised by the tariff fell to very low levels. In fiscal year 2023, customs duties raised about 2 percent of the federal government’s revenue. In poorer developing countries, the share of government revenue coming from import duties is substantially higher.

Restriction

A second reason that countries impose tariffs is to restrict imports and protect domestic producers from foreign competition. Domestic industries and their workers do not typically like foreign competition, which they see as taking their sales and jobs away from them. An import tariff reduces competition from abroad and helps expand domestic production in those industries, although other industries that depend on trade would suffer.

Industries that face foreign competition may lobby the government for protection [see Protectionism] from imports. Demands for protection are often self-serving, but sometimes others believe that such protection may be justified. In his famous Report on Manufactures (1791), Treasury Secretary Alexander Hamilton advocated subsidies and tariffs to help promote domestic industries on grounds of national defense and the promotion of manufacturing (Sylla 2024). The infant industry argument for protection contends that domestic industries could be competitive against their foreign rivals if they were given temporary protection to gain production experience and thereby reduce their costs (something known as learning by doing). Whether or not this is true is hard for policymakers to determine. Economists are also skeptical about whether tariffs are the right policy to help industries reduce costs (Baldwin 1969). An additional problem is that often the infant doesn’t grow up but stays protected.

Economists have engaged in a lively debate about how much such tariffs helped promote American manufacturing in the nineteenth century. Some have argued that protective tariffs helped make the United States an industrial power, while others contend that it reduced consumer choice and competitive pressure, reducing economic efficiency.2

Reciprocity

A third justification for tariffs is reciprocity. This can take the form of a carrot or a stick. The carrot version is that a country negotiates to reduce its tariff if other countries reciprocate and reduce their tariffs as well. Such negotiations can produce trade agreements [see International Trade Agreements] such as the North American Free Trade Agreement (NAFTA, now known as USMCA for U.S.-Mexico-Canada Agreement) which abolished tariffs on trade between the United States, Canada, and Mexico. The European Economic Community (EEC), first formed in 1957 and now known as the European Union (EU), eliminated tariffs on trade among participating countries in Western Europe. The goal of this form of reciprocity is to reduce trade barriers and allow bilateral trade to expand for the benefit of the participating countries.

The stick form of reciprocity is retaliation, in which a country raises its tariff against the goods of another country in retaliation for raising its tariffs, violating a trade agreement, or engaging in unfair trade practices. For example, in 2018, the Trump Administration imposed a broad set of duties against imports from China for keeping its market closed and stealing U.S. intellectual property. China and the EU imposed retaliatory duties against U.S. exports when the Trump Administration put tariffs on imported steel. Such retaliatory “trade wars” reduce trade, usually with the goal of bringing the other country to the bargaining table to negotiate the problem away.

Despite these recent retaliatory trade wars, tariff levels are relatively low for most products in market economies. In the mid-twentieth century, tariffs were relatively high and have come down substantially since then. For the United States, in the 1920s and 1930s, the average tariff on dutiable imports was about 40 percent and the average tariff on total imports was about 15 percent. (The difference between the two figures is because about two-thirds of U.S. imports entered duty free.) Since World War II, U.S. tariffs have generally been reduced in trade agreements. In 2023, the average tariff on dutiable imports was about 7 percent and the average tariff on total imports was about 2.5 percent. The same is true for other countries. The World Trade Organization’s World Tariff Profiles indicates that the European Union has import duties of about 5 percent, Japan about 4 percent, and China about 7 percent, on average. Of course, countries also maintain many non-tariff barriers, such as regulations restricting imports, that are more difficult to measure.

Economic Effects of a Tariff

What are the economic benefits and costs of import tariffs? The economic impact can be examined in one of two ways: on an individual product basis (partial equilibrium, looking at supply and demand for a particular good), or on an economy-wide basis (general equilibrium, looking at many markets simultaneously). Let’s consider each approach in turn.

Suppose the U.S. government imposes a tariff on imported sugar. This tax discourages the importation of sugar and the domestic price rises. The higher price reduces the quantity of sugar that consumers demand but increases the quantity of sugar that domestic producers are willing to supply. As a result, imports fall, being squeezed by lower domestic demand and higher domestic supply. Because it increases domestic production of sugar and decreases domestic consumption, the tariff is equivalent to a production subsidy and a consumption tax.

In changing production and consumption, the tariff redistributes income. Domestic consumers lose from the higher price, which goes partly to domestic producers (in the form of higher prices) and partly to the government (in the form of tax revenue). However, consumers lose more than producers and the government gains, meaning that there are “deadweight losses” (economic inefficiencies) associated with the tariff. The production deadweight loss is the extra costs that are incurred in increasing domestic production (beyond what would have been produced at the world price) and the consumption deadweight loss is the lost benefits to consumers who used to purchase the good (at the world price) but no longer do so. These deadweight losses can be considered lost gains from trade as a result of reducing trade.

Tariffs versus Quotas

Note that a tariff can be contrasted with a quota, which is a quantitative restriction on the volume of imports entering a country. Tariffs and quotas have similar effects: it doesn’t matter if one raises the domestic price of imported goods (via a tariff) and thereby reduces the quantity of imports, or if one reduces the quantity of imports (via a quota) and thereby raises the price. However, they differ in two important respects. First, a tariff is a tax that raises revenue, whereas a quota creates a “quota rent” (the markup of imported goods in the domestic market) that does not go to the government unless it auctions off the quota. Sometimes importers who are allocated the quota capture the rent by buying low on the world market and selling high in the domestic market; sometimes it is the foreign exporters who capture that markup. It depends on how the quota is allocated. Second, if competition is not very strong in the domestic market, the quota will give domestic producers market power that they would not have under a tariff. With a tariff, there is a limit to how much domestic producers can raise their price because imports are always a threat; that threat of additional imports is lost if a quota is in place.

Who Pays the Tariff?

A key question is the incidence of the tariff, or, “Who pays the tariff?” A simply numerical example might help clarify the matter. Suppose the world price of sugar is $100 per ton and an importing country imposes a 20 percent import duty. If the world price is unchanged, the new domestic price facing both producers and consumers in the protected market will be $120. In this case, consumers pay the full amount of the tariff.

But if the importing country is large enough, the tariff could depress the demand for sugar enough that the world price of sugar falls. In that case, the incidence of the tariff is not completely on consumers in the protected market; exporters pay some of the tax. Suppose that as a result of the 20 percent tariff, the world price of sugar falls from $100 to $90 per ton. In that case, the 20 percent tariff amounts to $18 and the new domestic price rises to only $108. In this example, the domestic price rises by 8 percent and the world price falls by 10 percent. The cost of the tariff is shared between foreign exporters (who must accept a lower price) and domestic consumers (who pay a higher price but not the full amount of the tariff).

Which scenario is more likely? Several studies carefully traced the impact of the tariffs imposed by the Trump Administration during its first term in office. Amiti, Redding, and Weinstein (2019) and Fajgelbaum, Goldberg, Kennedy, and Khandelwal (2020) found that prices of imports targeted by tariffs did not fall, implying complete pass-through of the tariffs to consumer prices. Fajgelbaum et al. also found that, after accounting for tariff revenue and gains to domestic producers, the tariffs reduced U.S. aggregate real income by $7.2 billion, or 0.04% of GDP, a measure of the deadweight loss of the tax.

It is important to recognize that imposing a tariff on one set of goods has ramifications for other downstream sectors of the economy. For example, when the United States protects its steel industry, the higher price of steel raises the production costs for other steel-using sectors of the economy, such as machinery, automobiles, and farm equipment. This makes them less competitive against other foreign producers who do not have to pay higher prices for their steel inputs. Research by Flaaen and Pierce (forthcoming) indicates that the tariffs resulted in more jobs being lost in steel-using sectors than were gained in the steel-producing sector.

What If Not Some but All Imports Are Taxed?

Supply and demand help us figure out the impact of a tariff on a particular product. But what if a country imposes a tariff on all imports? Such a tariff will affect the whole economy, not just the supply and demand for one good. In this case, it is misleading to say that producers benefit and consumers are harmed because there are many producers and many consumers. In this case, which economists call general equilibrium, the tariff results in some sectors of the economy expanding (those competing against imports) and other sectors of the economy contracting (those exporting or relying on imported intermediate goods). The expanding sectors will draw resources (capital and labor) away from other sectors of the economy that will shrink. For example, in the early nineteenth century, Britain imposed something known as the Corn Laws, which were tariffs on imported wheat and other grains. This expanded agricultural production but did so by shifting factors of production (capital and labor) away from the manufacturing sector.

General equilibrium allows us to see what happens to sectors of the economy other than those protected from imports, such as sectors producing for export. One consequence of an import tariff is that not just imports fall, but exports as well. This important proposition, known as the Lerner symmetry theorem (named after Abba P. Lerner), states that an import tariff is analytically equivalent to an export tax. If a country reduces how much it buys from the rest of the world in imports, it will not need to sell as much to the rest of the world in exports. The result is surprising because many people would favor imposing an import tariff but would oppose imposing any export taxes. One mechanism behind this phenomenon is the exchange rate: an import tariff will lead to an appreciation of the country’s currency, which will reduce exports [see Foreign Exchange].

Like the deadweight losses previously noted, there are efficiency losses to tariffs in general equilibrium. That is, by reducing trade, a country imposing a tariff is reducing the gains from trade. As a country increases its tariff and approaches autarky (a situation of no trade), all of the gains from trade will be erased.

Tariffs can also affect domestic income distribution in general equilibrium. A famous paper by Wolfgang Stolper and Paul Samuelson (1941) suggests that, in a simple framework with two goods and two factors of production (say, capital and labor, or skilled and unskilled labor), a tariff increases the reward to one factor and reduces the reward to the other. For example, if a tariff raises the relative price of the unskilled labor intensive good, it will increase the real wage of unskilled workers and decrease the real wage of skilled workers. This striking result demonstrates why there is a political debate over trade policy—not every group in society benefits from free trade (or from high tariffs) and there are winners and losers from every policy change. Of course, this theoretical result does not take into account many other issues, such as the economic growth effects of tariffs, the increased availability of new goods, and so forth.

Ever since Adam Smith wrote the Wealth of Nations in 1776, economists have, in general, not been fans of protectionist tariffs because tariffs reduce trade and the gains from trade. Are there any cases in which import tariffs are beneficial and do not result in efficiency losses that reduce national income?3 That could happen if there were an offsetting factor, for example an externality or departure from perfect competition, that creates an economic benefit that more than offsets the standard efficiency loss. Two such cases have received the most attention.

The first case was discussed earlier: if by imposing a tariff a country can reduce the price of its imports (or increase the price of its exports), making other countries pay the tariff, then that benefit might exceed the standard deadweight loss of the tax. This is known as the “optimal tariff” argument; a country improves its terms of trade at the expense of other countries. For example, for many decades the Organization of Petroleum Exporting Countries (OPEC) has had market power in the world oil market. It restricted its oil exports (an implicit export tax) in order to increase the world price of oil for its benefit and at a cost to other countries. (This is known as a “beggar thy neighbor policy” because it enriches one set of countries while impoverishing others.) A country that has monopoly power in its exports or monopsony power in its imports could, in principle, benefit from a tax on imports or exports.

The second case is if there are important positive externalities coming from certain domestic industries that might be lost as a result of foreign competition. Many economists have suggested that manufacturing production generates positive technological spillovers and therefore deserves government support. One example, mentioned earlier, is the infant industry argument for protection. These cases are controversial because it is difficult to determine the precise nature of the externality that the government is supposed to correct with appropriate action. In general, economists have favored subsidies rather than tariffs as a way of promoting certain industries or sectors of the economy (Bhagwati and Ramaswami 1963). Furthermore, in a seminal paper, Baldwin (1969) questioned whether a tariff was targeted enough to correct any of the market failures that were said to be behind an infant industry.

Tariffs are sometimes proposed as a way of reducing a trade deficit. But trade deficits are determined by macroeconomic factors, such as the degree to which capital can move between countries, and the balance between a country’s national savings and investment. Tariffs tend not to affect these underlying determinants of trade deficits and are largely ineffective at reducing them.

For developing countries, tariffs not only reduce consumer choices but also can harm a country’s growth prospects. Countries that are behind the technology frontier need imports of foreign capital goods to help their producers become more efficient. Tariffs that restrict such imports are an obstacle to such countries catching up to the productive efficiency and higher income levels enjoyed by other countries (Irwin 2025).

For example, under its communist leader Mao Zedong, China was largely closed to international trade and remained one of the poorest countries in the world. In the late 1970s, China’s new leader, Deng Xiaoping, opened the economy to trade and foreign investment. For several decades thereafter, China’s economy grew at close to double digit rates, raising incomes dramatically and sharply reducing poverty. A similar process has been observed in countries such as India and Vietnam after they opened to trade. However, trade is an opportunity, not a guarantee of economic success, and other countries in Latin America and Africa have not seen such dramatic growth rates after they reduced their trade barriers.

References

Amiti, Mary, Stephen J. Redding, and David E. Weinstein. 2019. “The Impact of the 2018 Tariffs on Prices and Welfare.” Journal of Economic Perspectives, 33 (4): 187–210.

Baldwin, Robert E. “The Case against Infant Industry Tariff Protection.” Journal of Political Economy, Vol. 77, No. 3 (1969), pp. 295-305.

Baldwin, Robert E. 1982. “The Inefficacy of Trade Policy.” Essays in International Finance No. 150, Princeton University, December. https://ies.princeton.edu/pdf/E150.pdf

Bhagwati, Jagdish, and V. K. Ramaswami. “Domestic Distortions, Tariffs and the Theory of Optimum Subsidy.” Journal of Political Economy 71, no. 1 (1963): 44–50.

Cavallo, Alberto, Gita Gopinath, Brent Neiman, and Jenny Tang. “Tariff Pass-Through at the Border and at the Store: Evidence from US Trade Policy.” AER: Insights 2021, 3(1): 19–34

Corden, W. M. Trade Policy and Economic Welfare. Oxford: Clarendon Press, 1974.

Fajgelbaum, Pablo D., Pinelopi K. Goldbrg, Patrick J. Kennedy, and Amit K. Khandelwal. “The Return of Protectionism,” Quarterly Journal of Economics 135 (2020):

Flaaen, Aaron, Ali Hortaçsu, and Felix Tintelnot. 2020. “The Production Relocation and Price Effects of US Trade Policy: The Case of Washing Machines.” American Economic Review, 110 (7): 2103–27.

Flaaen, Aaron, and Justin Pierce. “Disentangling the Effects of the 2018-2019 Tariffs on a Globally Connected U.S. Manufacturing Sector.” Review of Economics and Statistics, forthcoming.

Irwin, Douglas A. “Did Late-Nineteenth-Century U.S. Tariffs Promote Infant Industries? Evidence from the Tinplate Industry.” Journal of Economic History Vol. 60, No. 2 (2000), pp. 335-360.

Irwin, Douglas A. Against the Tide: An Intellectual History of Free Trade. Princeton: Princeton University Press, 1996.

Irwin, Douglas A. Clashing over Commerce: A History of U.S. Trade Policy. Chicago: University of Chicago Press, 2017.

Irwin, Douglas A. “U.S. Trade Policy in Historical Perspective.” Annual Review of Economics 12 (2020): 23-44.

Irwin, Douglas A. “Does Trade Reform Promote Economic Growth? A Review of Recent Evidence,” The World Bank Research Observer, 2025;, lkae003, https://doi.org/10.1093/wbro/lkae003

Lerner, Abba P. “The Symmetry between Import and Export Taxes.” Economica 3, no. 11 (1936): 306–13.

Russ, Kadee, and Lydia Cox, “Steel Tariffs and U.S. Jobs Revisited,” Econofact, February 6, 2020, at: https://econofact.org/steel-tariffs-and-u-s-jobs-revisited

Stolper, Wolfgang, and Paul A. Samuelson. “Protection and Real Wages.” The Review of Economic Studies, Vol. 9, No. 1 (1941), pp. 58-73.

Sylla, Richard. 2024. “Alexander Hamilton’s Report on Manufactures and Industrial Policy.” Journal of Economic Perspectives, 38 (4): 111–30.

Footnotes

[1] The three Rs (revenue, restriction, reciprocity) are discussed in detail in Irwin (2017) and Irwin (2020).

[2] Solid empirical evidence on infant industries is scarce. For example, the U.S. tinplate industry did not receive much tariff protection until 1890, after which it blossomed. One might think that the tariff gave rise to this manufacturing industry, but it turned out that the principal impediment to the industry was the high tariff on imported steel, which raised the cost of production of domestic tinplate products and made them uncompetitive (Irwin 2000).

[3] Adam Smith fully conceded that there were non-economic objectives, such as revenue or national defense, that could be achieved through the use of tariffs.

Selected Works

Henry George. Protection or Free Trade. Available at the Library of Economics and Liberty.

Frank William Taussig. Some Aspects of the Tariff Question. Available at the Library of Economics and Liberty.

Lauren Landsburg. “Taken to the Cleaners. Library of Economics and Liberty, March 5, 2018.

Donald J. Boudreaux. Comparative Advantage. Concise Encyclopedia of Economics.