A tariff is a tax on imported goods that governments use to regulate trade. Tariffs can affect prices, economic policies and investment decisions, making them a key factor in global commerce.
Wise takeaways
- Tariffs are fees on imported goods that governments use to regulate trade and generate revenue.
- They can disrupt global supply chains and impact corporate profits, particularly for businesses reliant on imported materials.
- Tariffs often lead to higher prices for businesses and consumers, as companies pass on added costs.
- Markets and investors react to tariff changes, with global portfolios facing heightened risk from trade disputes.
- Tariffs can protect domestic industries by making foreign goods less competitive, but they may also trigger retaliatory trade measures.
What is a tariff?
The simplest way to think of tariffs is as an extra fee on imported goods. Governments charge and collect these costs from foreign companies importing their products. Tariffs can be applied to goods ranging from raw materials and components to finished consumer goods, and the money from these tariffs goes to the importing country’s government.
The purpose of tariffs is usually to protect and promote domestic industries by making imported goods more expensive and less competitive. Since tariffs increase the price of imports, this translates to higher prices on foreign goods for customers. In this respect, domestic producers have an advantage since they don’t have to pay the extra tariff charges and pass those prices on to the consumer.
How do tariffs work?
When a product is brought into a country with a tariff, the company receiving it (the importer) pays a tax on the shipment. This tax increases the total cost of the goods, which can make them more expensive for businesses and consumers.
There are a few different ways governments could calculate this fee:
- Ad valorem tariffs: These tariffs are based on a percentage of the price of each imported item. For example, if a product costs $100 and has a 10% ad valorem tariff, the importer would pay an additional $10 in tax for each unit they bring into the country.
- Specific tariffs: These tariffs use a fixed fee based on some measurable attribute, such as weight or quantity. For instance, a specific tariff might impose $2 per kilogram on a particular commodity.
- Compound tariffs: These tariffs combine a percentage rate and a flat import fee. So, if a product is subject to a 10% ad valorem tariff plus a $2 per kilogram charge, an importer would need to pay both fees based on the item’s value and weight.
Who pays for tariffs?
The business that brings a product with a tariff into the country (the importer) is responsible for paying tariffs. However, these businesses are often forced to raise the price of these products to make a profit, which results in the consumer being affected by tariffs, too.
For example, when President Donald Trump placed a 30-50% tariff on imported washing machines in 2018, retail washing machine prices rose approximately 12% that year. American consumers collectively paid about $1.5 billion more for washing machines while the tariffs were in effect2.
So, while businesses that import foreign products actually pay tariffs, consumers also feel the effects on their wallets.
Are tariffs good for the economy?
Although only importers directly pay tariffs, these fees have profound trickle effects on the prices of goods and services. Economists point out that consumers end up paying tariffs indirectly due to the overall increase in prices3. Any company that relies on goods from foreign nations often raises consumer prices to remain profitable.
Therefore, businesses that depend on foreign materials or sell products overseas tend to be the most sensitive to tariffs, which often results in poorer earnings reports and weaker share price performance. Investors holding stocks in these industries typically notice extra volatility in their portfolio as the market adjusts to the “new normal” after tariffs are introduced.
What do economists say about tariffs?
The International Monetary Fund (IMF) notes that trade tensions and tariffs can lead to a decrease in global economic growth, which could hurt a broad array of sectors. Specifically, the IMF estimates that increased trade restrictions take roughly $7.4 trillion out of the global economic output in the long term4.
Research out of UC Davis suggests tariffs decrease economic productivity. According to research from UC Davis economic professor Christopher Meissner, U.S. industries became less efficient and less innovative when tariffs increased between 1870 and 1909. His findings show that for every 10% rise in tariff rates, the productivity of American businesses — meaning their ability to produce goods efficiently and competitively — declined by 25% to 35%5.
More recent data from the Federal Reserve Bank of New York found that tariffs imposed by the U.S. increased consumer and business costs6. JPMorgan also reports that tariffs are typically linked to higher odds of inflation, citing the 2018-2019 tariffs between the U.S. and China as a concrete example7.
Will tariffs affect my 401(k) or other investments?
With tariffs affecting businesses, consumers, economic growth and productivity, it’s not a surprise that tariffs often affect investors’ 401(k)s and other investments. While investors with a diversified portfolio might not feel the brunt of tariff-related risks, tariffs often have a negative impact on market prices and sentiment8. The uncertainty tariffs bring into the market also raises fears of retaliation, currency exchange fluctuations and changes in consumer spending, all of which tend to produce a hesitant market environment. There’s no way to know exactly how new tariffs will impact everyone’s portfolio, but investors typically expect a bump in volatility.
How do tariffs impact the S&P 500?
Higher tariffs may put a drag on the global economy, with historical data suggesting indexes like the Standard & Poor’s 500 aren’t as likely to post gains when tariffs are in force. For example, Goldman Sachs researchers discovered that for every 5% increase in U.S. tariff rates, the S&P 500’s earnings per share went down by about 1% to 2%9.
Historical data suggests a negative correlation between tariffs and the performance of stocks in the S&P 500. Since the S&P 500 contains 500 of the largest publicly traded companies in the U.S., many of these businesses have international exposure, which explains why investors fear tariffs will adversely impact their bottom line. Some investors who decide to sell may also fear the broader implications of tariffs — including reduced consumer spending and higher unemployment — and how these could adversely impact corporate earnings. The negative association of tariffs on the S&P 500 sometimes leads investors to look for safer alternatives to park funds during these periods.
Examples of historic tariffs
To get a better understanding of how tariffs work and impact the economy, let’s take a closer look at a few real-world examples:
The Smoot-Hawley Tariff Act (1930)
At the start of the Great Depression, the U.S. government imposed the Smoot-Hawley Tariff on thousands of different types of imported products to protect American farmers and businesses from foreign competition. However, this act triggered a wave of retaliatory tariffs from other nations and further exacerbated the sharp decline in international trade during the Great Depression12.
In 1934, President Franklin D. Roosevelt signed the Reciprocal Trade Agreements Act, which granted the president the authority to negotiate tariff reductions with other countries13.
While the extent of the Smoot-Hawley Tariff’s full impact remains a matter of debate, it significantly reduced global trade while in effect.
US Steel Tariffs (2002)
To support local steel manufacturers, President George W. Bush imposed tariffs ranging from 8% to 30% on imported steel in 200214. However, similar to the Smoot-Hawley Tariff, later research suggests that the broader implications of these tariffs actually harmed the U.S. economy by raising steel prices, increasing costs for automotive and construction industries, among others, and leading to significant job losses in steel-consuming sectors.
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Eric Esposito is a freelance contributor on MoneyWise with an interest in financial markets, investing, and trading. In addition to MoneyWise, Eric’s work can be found on financial publications such as WallStreetZen and CoinDesk. When not researching the latest stock market trends, Eric enjoys biking, walking his dog, and spending time with family in Central Florida. Eric holds a BA in English from Quinnipiac University.
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