The Nature of American Tariffs

With all the buzz surrounding the recent increase in U.S. tariffs, a discussion regarding the nature of tariffs is timely. We often hear commentators opine that higher tariffs are certain to be a drag on the U.S. stock market. However, a brief review of the nature, purpose, and history of American tariffs, and the current imbalance in tariff rates between the U.S. and its trading partners may lead to a different perspective. Although nothing in the future is known, the higher tariffs that are now in place may be more a mixed bag than commonly thought.

First, a basic fact: A tariff is nothing more than a tax. The U.S. Commerce Department charges the tax on imported goods.

The motivations for levying a tariff are many, but the most common is to protect domestic companies and workers. For example, when China subsidizes their companies so that they can price goods at artificially low prices, and then floods our market with those goods, American companies may be forced to fire workers to cut costs and  compete. They may decide to close their manufacturing facilities and move them abroad to cut labor costs further, or they may go out of business altogether. This results in higher unemployment in America. A tariff solves this problem by making the imported goods more expensive, which allows American companies to continue doing business without these draconian measures. The cost of this is higher prices of goods paid by the American consumer.

Tariffs may also be levied in the interest of national security. Industries with perceived strategic importance, such as defense industries, enjoy significant levels of tariff protection. Still another motivation can be retaliation. For example, in 2009 the U.S. placed a 300% import tariff on Roquefort cheese following the EU’s ban on hormone-treated beef from the US.

Tariffs are not the only barrier to trade. Other methods include the issuing of licenses. The license is given only to certain businesses by the government which allows the business to import a certain type of good into the country. Others are excluded. This causes a restriction of competition and higher prices of goods. Import quotas are often imposed along with licenses, placing restrictions on the volume of a certain good that can be imported.

A record of the decline of American tariffs as a percentage of federal revenue in 25-year increments follows.* Be aware that the percentages in intervening years differed somewhat:

Observe that over our history, tariffs have dropped from almost the sole source of revenue to almost none of it. It is also noteworthy that tariffs were the primary tax during the entire 19^th century; which was the very timeframe during which the greatest expansion in American prosperity took place. From our founding through the beginning of World War l, America grew from a fledgling group of colonies to become the greatest economic power in the world. Let this alone dispel the notion once and for all that higher tariffs will necessarily impede prosperity.

There have been fears that our recent tariffs will lead to a “trade war”, in which our tariffs will be met in kind by higher tariffs on US exports. The last trade war took place in 1930 due to the Smoot-Hawley tariff, which placed very high (40% to 50%) tariffs on 900 imported goods to protect American farmers who had been ravaged by the Dust Bowl. Other countries retaliated, food prices rose for Americans who were already suffering from the Great Depression, and global trade was forced down by 65%. This was not the intended result.

The newly announced tariffs will be levied on 5,600 Chinese goods at a rate of 25% beginning in October of 2018. It is likely that there will be some level of retaliation, but it is also likely that the result will be better for the US this time around, for two reasons:

• First, as it now stands, the U.S. has one of the most open markets in the world, with a current average tariff rate of 1.6%**. Tariffs imposed by China are double ours at 3.5%. Any move toward parity causes China to lose more than the U.S.
• Secondly, trade surplus nations such as China are hurt more in a trade war than trade deficit nations such as the U.S. There is simply more Chinese product to tax than there is American product.

These factors are likely to cause China to blink first.

In summary, in this writer’s opinion, tariffs can be a valuable form of taxation, and a useful tool in bringing fairness to international trade and protecting domestic companies and workers. Our domestic economy and markets can continue to thrive in a climate of higher tariffs. It would be a mistake to assume that a policy of higher tariffs will have a negative influence on the U.S. stock market.

*Graphs sourced from MetroCosm: http://metrocosm.com/history-of-us-taxes/

**To understand how much lower U.S. tariffs are than those in other countries, consider that U.S. tariffs are not assessed on the final retail sales price, nor are they imposed on the wholesale price. They are not even calculated on what the importer pays at the dock. The duties are imposed on a price even lower than that.

To use a hypothetical example of how they are calculated, suppose that Panasonic wants to sell television sets for $1,000 in the U.S. It goes to a middleman in Hong Kong who has a contact in Beijing who works in a Chinese factory. The Hong Kong middleman pays his contact $200 for each TV from the factory. Panasonic agrees to pay the Hong Kong middleman $400 for each TV and picks them up off the boat in Long Beach, California.

Let’s assume there is a 25% U.S. tariff on Chinese Televisions. The tariff would only be $50 because it is calculated on what the Hong Kong middleman (says he) paid his contact at the Television factory ($200). Of course, the actual factory price is often higher than what is claimed.

Because of this accounting sham, we are collecting far less in import tariffs than other countries do, even if the stated rate is equal. For the record, every other country calculates tariffs on the retail price. For example, if the Eurozone was importing American-made television sets under the same assumptions laid out above, a 25% tariff collected by the Eurozone would be $250; five times as much as the U.S. would charge based on a 25% tariff rate.