What Is a Tariff?

What Is a Tariff and Why Are They Important?Tariffs—taxes on imported goods—have been a feature of U.S. trade policy since the nation’s founding. Until the Civil War, they made up the vast majority of government revenue, and remained an extremely important revenue source until the creation of the formal income tax in 1913.

While high tariffs largely fell out of favor after World War II, thanks to concerns over reduced trade and rising costs for consumers, they have made headlines in recent years as a central tool in U.S. trade policy toward China, among other countries.

Definition and Purpose of Tariffs

In simple terms, a tariff is a tax that a country’s government imposes on goods that are imported from other countries. The importing business pays the tariff when the goods cross the border into the country, typically at a seaport or airport. The most common types of tariffs are “ad valorem” tariffs, which are set as a fixed percentage of the value of the imports, and “specific” tariffs, charged as a fixed amount on each unit of an imported good.

“There are basically three motivations for using tariffs,” says Douglas Irwin, professor of economics at Dartmouth College. In his book Clashing Over Commerce: A History of U.S. Trade Policy, Irwin calls these the “three Rs”: revenue, restriction and reciprocity. “They’re a tax, so they raise revenue. But they also keep out foreign goods, so they’re restricting imports, usually to help out some domestic firms that are facing foreign competition. They can also be used for reciprocity—if we have tariffs and other countries do too, we can negotiate to bring those down and promote trade, or if your market’s closed to us, we can raise tariffs against you to retaliate.”

Tariffs in Early US History

The use of—and debate over—tariffs goes back to the founding of the United States. Many in the new nation saw free trade as an important principle, especially in contrast to Britain’s control of colonial trading practices. But tariffs also provided an important source of revenue, a need that the framers of the U.S. Constitution provided for in Article I, Section 8 of that founding document, which gives Congress the “Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States.” On July 4, 1789, President George Washington signed the Tariff Act of 1789, the first substantive legislation passed by Congress.

Alexander Hamilton, the nation’s first treasury secretary, strongly argued on behalf of tariffs not only a key revenue source but a way of protecting fledgling domestic industries in the new nation. In his famous 1791 “Report on the Subject of Manufactures,” Hamilton argued that high tariffs were the key to enabling American industries to grow and breaking the nation’s continued dependence on British trade and manufacturing.

Tariffs Through the 19th Century

In the aftermath of the War of 1812, tariff legislation was used to further encourage the nation’s domestic industrial growth. In 1828, Congress passed a bill raising tariffs to as much as 50 percent, the steepest increase in the country’s history. Reactions to the hikes deepened growing tensions between the industrial North—where many people favored high tariffs to protect homegrown manufacturers—and the more agricultural South, which relied on exports to Britain and other countries.

“What you see throughout U.S. history is this tussle between, are you an exporter and want low tariffs, or are you an import-competing industry and want high tariffs,” Irwin explains. “They’re located in different parts of the country, so those different parts of the country fight with one another over what the trade policy ought to be.”

Before the Civil War, tariffs represented some 90 percent of U.S. government revenue. That share fell to about 50 percent with the advent of new taxes to pay for the war effort. Tariffs would become relatively insignificant as a source of government revenue after the introduction of the income tax in 1913, but they remained an important tool for protecting domestic producers from foreign competition.

Impact of the Smoot-Hawley Tariff Act (1930)

In the wake of the stock market crash of 1929, Congress passed the Smoot-Hawley Tariff Act—named for its chief sponsors, Senator Reed Smoot of Utah and Representative Willis Hawley of Oregon—which raised the country’s already high average tariff rate by some 20 percent. In signing the Smoot-Hawley tariff into law in June 1930, President Herbert Hoover disregarded the advice of more than 1,000 economists who pleaded with him to veto the bill.

“People thought it might help the economy, because if you keep out imports, then you have to buy domestic goods,” Irwin says. “But what they forget is that if we keep out imports, we impinge on the ability of other countries to buy our exports. Then when you compound the fact that other countries start raising tariffs against the U.S. too, it puts trade on a downward spiral.”

Stock Market Crash of 1929

Various foreign countries soon enacted retaliatory tariffs, and between 1929 and 1932 U.S. imports from and exports to Europe fell by some two-thirds, with overall global trade declining in a similar fashion.

Though the global economic woes didn’t start with Smoot-Hawley, many economic historians agree that the tariff bill significantly worsened the Great Depression, according to a 1995 survey published in The Journal of Economic History.

Tariff Policy Shift After World War II

The Smoot-Hawley Tariff Act would be the last legislation in which Congress set tariff rates, as the legislative branch gradually ceded authority over trade policy to the executive. This shift began in 1934 when President Franklin D. Roosevelt signed into law the Reciprocal Trade Agreements Act, ushering in a new era of U.S. trade policy based on the principle of negotiating lower tariffs with other countries to promote economic growth overall.

“After World War II, we wanted to get the world economy back on its feet, and one way to do that is to stimulate world trade,” Irwin says. “So we said, we’re willing to cut our tariff if other countries are willing to sign up and reduce theirs as well.”

This principle continued to drive U.S. trade policy in the decades to come, leading to agreements such as the General Agreement on Tariffs and Trade, the World Trade Organization and the North American Free Trade Agreement, which were all negotiated by U.S. presidents, rather than Congress.

“We’ve empowered the president, even though tariffs are in the Constitution—Article I—for the Congress,” Irwin says. “Congress has delegated that, and the president is the most important leader on trade policy now.”

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