How Do Tariffs Work?

Like the Townshend Acts and Bacon’s Rebellion, tariffs are one of those topics you may vaguely remember from high school history class. Let’s take another look at how tariffs work—and what happens to the economy when they don’t.

Tariffs are taxes imposed on imports or exports. If the U.S. government imposes a 25 percent tariff on imports of, say, Canadian timber, it means that American companies buying timber from Canada will have to pay a quarter of the price of timber to the U.S. government. 

Tariffs can be imposed for a number of reasons, not all of them economic. Because they make importing more expensive, they can be used to promote the development of domestic industries. They can also be used as a geopolitical weapon to exert pressure on trading partners or to punish non-allies. Like all kinds of taxes, they are also a means of generating government revenue.

Crucially, none of these measures is foolproof. If the U.S. imposes tariffs on Canada, for example, Canada may simply start trading with countries that don’t impose tariffs, cutting the U.S. out of the equation. That could then weaken the U.S. economy and its ability to engage in international trade.

Tariffs impact companies that rely on imports as well as ordinary consumers. If a country that imposes tariffs fails to develop domestic production and find new trade partners—a process that can take years, if not decades—tariffs are bound to raise consumer prices, because the importers will need to recuperate the additional costs they pay to the government through higher markups on the products they sell. As a result, tariffs have often resulted in economic recessions in the countries that impose them. 

When Tariffs Work, and When They Don’t

That’s not to say that tariffs are always a bad thing—they can be useful, but only under specific circumstances. The Tariff Act of 1789, one of the first laws passed after the United States won its independence from Great Britain, stimulated the growth of the U.S. economy and manufacturing and helped the federal government pay off its war debts. 

However, historians have stressed that these measures worked only because the tariffs were small and evenly distributed across various industries, meaning the U.S. was able to grow its own economy without cutting itself out of the global trade network and alienating its foreign allies. 

For an example of how not to use tariffs, we need to look no further than William McKinley. As a Republican congressman from Ohio, he erroneously believed that tariffs would make the U.S. more prosperous and spearheaded the McKinley Tariff Act of 1890, which imposed an average 50 percent tariff on imported goods. Trading partners responded with tariffs of their own and made basic goods more expensive for lower- and middle-class Americans. The tariff war triggered a revolt among voters in the midterm elections just a month later; Democrats gained 86 seats in the House and McKinely lost his seat. 

The Smoot-Hawley Tariff Act of 1930 is another example of how not to use tariffs. Signed into law by Republican President Herbert Hoover, the act increased U.S. import tariffs—which were already high compared to today’s standards—by an additional 20 percent. As a result, the value of U.S. exports fell from $7 billion in 1929 to $2.5 billion in 1932, while international trade plummeted 65 percent. 

In the end, the act only exacerbated the effects of the Great Depression, which continued until it was brought under control by Hoover’s successor, Franklin Delano Roosevelt, who lifted many of the tariffs imposed by his successors.

In theory, tariffs should boost U.S. manufacturing in the long run, but the benefits can take years to manifest. And in the interim, tariffs often spawn recessions because the U.S. has a deficit economy, meaning it imports more than it exports. Tariffs can work under specific circumstances and when implemented through fair, judicious means by politicians focused on achieving long-term goals rather than short-term wins—but history shows that has seldom been the case.

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