This comes via the Twitter account of President Donald Trump:
"I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so. It will always be the best way to max out our economic power. We are right now taking in $billions in Tariffs. MAKE AMERICA RICH AGAIN"
Set aside for a moment the unreality of presidential statements sharing a platform with homeroom drama. For better or worse that ship sailed long before Trump took the stage. Members of Congress have spent years online acting… well, acting like Baby Boomers typically do after they discover social media.
The question at hand is, has Trump's administration actually taken "in $billions in Tariffs"? [sic] In the middle of his semi-declared trade war with China (and Europe and Canada for some reason), has he forced those nations "to pay for the privilege" of doing business in the U.S.?
There aren't enough nopes in the universe. Here's why.
What Is a Tariff?
Tariffs, also known as "customs duties," are a tax levied by the government on imported goods. An ad valorem tariff is a percent tax, and the most common form of tariff. A unit tariff is defined as a set amount of money per unit of import.
They are charged at the point of entry into the country. So, for example, when Chinese firms ship steel to the U.S., current trade laws in the U.S. add a 25% ad valorem tax on that transaction.
Tariffs do not apply to services, only to goods and products.
Who Pays a Tariff?
Here's the part about tariffs that Trump gets the most wrong. The foreign government does not pay a tariff. When Chinese firms sell steel to the U.S., the government in Beijing does not pay a nickel.
Who does pay a tariff? Usually you do.
The company or individual that imports a product pays any relevant tariffs. This makes the product significantly more expensive to the importer. So, for example, when General Motors (GM - Get Report) imports tariff-burdened steel to build cars it pays a tax to the U.S. Treasury.
How tariffs disseminate is up to the importer. Typically, a company passes these costs along to the consumer, potentially increasing prices by up to the value of the entire tariff.
Exactly how that happens depends entirely on market forces. Companies in a very competitive market might choose to absorb some or all of the extra costs as reduced profit margin. Yet, while the American marketplace is highly competitive, this has also pushed most retail firms to run tight profit margins as it is. They often don't have the room to absorb much in higher per-unit costs.
This is what has happened in the wake of Trump's tariffs. Firms have raised prices on items from soft drinks to ATVs to pay the new import fees.
In the end tariffs function as a domestic sales tax. Local consumers, not foreign governments or exporters, pay the costs of a tariff in the form of higher prices for products on the shelf.
Terms of Trade Gains
In some situations, particularly when the importing country has significant leverage, it can achieve what economists call a "terms of trade gain." In layman's terms, the exporting country reduces its prices to compete with the new marketplace.
This happens rarely and is entirely situational.
When a country does see a terms of trade gain equal to or greater than the value of its tariff then that government unambiguously comes out ahead. The savings from reduced prices offset the tariff taxes, consumer prices remain largely unaffected and the government collects a new source of revenue.
It is essential to note that this very rarely happens.
What Is the Purpose of a Tariff?
Not to raise revenue.
The purpose of a tariff is to discourage imports and protect domestic industries from competition. By artificially making foreign products more expensive the government encourages consumers and companies not to buy them. Instead, people (in theory) will gravitate towards domestic industries not burdened by these taxes.
This has been the leading edge of Trump's argument on steel tariffs. He would like to boost the U.S. steel industry. By making it more expensive to purchase steel abroad, tariffs encourage companies to buy their steel from domestic manufacturers. Ideally this will boost sales to those industries.
Do Tariffs Raise Revenue?
Rarely, and when they do it comes out of your pocket.
It cannot be overstated that Americans pay every penny of a U.S. tariff. Most of the costs operate as a form of a complicated sales tax. The remaining costs reduce wages, depress hiring and (least often) reduce the profits of business owners.
So if the Treasury has, in fact, raised "$billions" from Trump's tariffs, it means that the Trump administration has passed a back-door tax hike on individual consumers worth billions of dollars.
In reality, however, tariffs rarely produce significant revenue. By way of context, import duties amount to less than 1% of modern federal tax collection. More importantly, the entire point of a tariff is for citizens to avoid it.
When the government passes an ordinary sales tax, the purpose is to raise revenue by taxing products as consumers buy them. However, as noted above, the purpose of a tariff is to actually discourage customers from buying the products being taxed.
So, for example, if Trump's steel tariff works as advertised companies will start buying more steel from U.S. suppliers. This means that they will not buy the tariff-burdened Chinese steel, helping domestic companies at the expense of foreign firms. The tariffs will have shifted consumption, not raised revenue.
The tariffs will raise some revenue as companies continue buying Chinese steel and passing those higher costs along to their consumers. The rest of these companies will switch to either domestic sources or countries not targeted by import taxes, with little total effect on government revenue.
What Are the Real Effects of Tariffs?
Tariffs rarely help domestic industries in any significant way. They do raise prices on consumers. This happens for three main reasons.
• First, as discussed above, when companies pay these import duties they pass the costs along to consumers.
• Second, the reason that politicians act to protect domestic industries in the first place is because they are more expensive than their foreign competition.
When a tariff is effective at shifting consumption back toward domestic industries it rewards this less efficient option. Prices go up because consumers now have to choose between products that have been heavily taxed and those which were more expensive to begin with.
• Third, tariffs reset prices market-wide by eliminating the most efficient competitor.
When a tariff eliminates the lowest-cost option, either by artificially raising prices or discouraging purchases altogether, companies both foreign and domestic no longer have to compete as aggressively. They tend to become less efficient, and prices go up across the board as a result.
This might have some rewarding effect if tariffs did shift significant spending back to domestic firms as intended. The truth is, though, that rarely happens. Here's why:
• There's almost always someplace cheaper than the U.S.
The key truth about imports is this: If domestic companies could make this product competitively, they would do so.
The upshot is that companies and consumers don't tend to switch back to local industry in the wake of tariffs. Instead, they look for the next competitive source. This is particularly true in the U.S. market, in which workers are extremely expensive by global standards. Virtually any labor-intensive product is cheaper to make elsewhere.
So most companies respond to tariffs by simply importing their products from someplace else. If Chinese bicycles become too expensive, American toy companies can buy them from Mexico or Vietnam. If steel becomes a problem, America can look to India or even Canada.
The only way to deter that would be to impose tariffs on the entire world. That would be a problem because…
• Nations tend to retaliate to tariffs.
A trade war is, essentially, when nations swap dueling tariffs. They escalate trade barriers higher and higher, hoping the other side breaks first under escalating consumer prices.
This is what happens when countries expand tariffs. It becomes a game of Whac-a-Mole, with countries swapping taxes against each other.
America is vulnerable to this. Approximately 12% of the American economy comes from exports, and the U.S. provides 14% of all services exports globally. As nations respond to Trump's tariffs in kind that section of the economy will diminish. The more trade barriers America puts up, the faster that will happen.
Tariffs Can Help Correct Trade Barriers
While tariffs tend not to raise revenue or protect domestic industry, they can achieve one policy goal:
• The value of tariffs is to encourage other countries to reduce trade barriers or to stop other protectionist measures.
Governments rely on tariffs to respond when a trading partner has acted to unfairly protect local industries. When a third party nation has erected its own trading barriers, or when it subsidizes domestic companies to give them an unfair advantage, tariffs can restore leverage.
Essentially, they amount to a statement "play by the same rules as everyone else or we won't trade fair either."
This is the central criticism of U.S. trade with China. While a full discussion of U.S./Chinese trade relations exceeds the scope of this article, the U.S. business community has long complained that Beijing gives its domestic industries unfair advantages when competing with American firms.
A smart system of tariffs, targeted against the correct industries, could answer concerns such as theft of intellectual property and government subsidies. This would require, however, that those laws be properly targeted… and a president who knows what a tariff actually does.