What Are Tariffs and How Do They Work?

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What Is a Tariff?

A tariff is a tax that governments place on goods coming into their country. You might also hear them called duties or customs duties—trade experts use these terms interchangeably. While most tariffs target imports, governments can also tax exports, though this happens far less often.

The process in the United States is straightforward. When a ship full of foreign goods arrives at an American port, U.S. Customs and Border Protection collects the tariff. The company importing the goods pays the tax, typically within 10 days of the goods clearing customs.

The most immediate effect of a tariff is simple: it makes imported products more expensive for Americans to buy. This basic function drives all the complex economic and political consequences that follow.

Think of a tariff as an economic wedge driven between what a foreign seller receives and what an American buyer pays. Without tariffs, an American company might buy a product from a foreign supplier for $100. If the U.S. government imposes a 25% tariff, the American company must now pay the $100 to the supplier plus a $25 tax to the U.S. government. The final cost becomes $125, while the foreign seller still only receives $100.

This price distortion is the core mechanism through which tariffs aim to alter economic behavior, discouraging imports and creating an incentive to purchase domestically produced alternatives.

How Tariffs Are Applied

Not all tariffs work the same way. The method used to calculate the tax has significant implications for businesses and consumers, affecting which goods are impacted most and how predictable the costs are.

Ad Valorem Tariffs: Taxing by Value

An ad valorem tariff is calculated as a percentage of the imported good’s total value. The Latin phrase means “according to value.” This is the most common type of tariff, particularly for manufactured goods with varying quality and prices.

The taxable value often includes not just the product’s price but also freight and insurance costs to get it to the destination port—a method called Cost-Insurance-Freight (CIF).

Some examples help illustrate how this works:

The United States charges a 2.5% tariff on most imported cars. On a car valued at $30,000, this adds $750 to the cost.

A 15% tariff on imported cheese valued at $1,000 results in a $150 duty.

High-value luxury items face steeper rates. A $5,000 imported watch might face a 20% tariff, adding $1,000 to its price.

The main advantage of percentage-based tariffs is that they maintain consistent protection for domestic producers even when prices change. If an imported product’s price increases, the tax amount also increases proportionally.

However, this creates challenges for businesses. Because the tariff amount ties directly to the good’s value, price fluctuations and currency volatility can lead to unpredictable costs, making it difficult to forecast expenses and plan budgets.

Specific Tariffs: Taxing by Quantity

A specific tariff charges a fixed amount per unit, weight, or volume, regardless of the product’s price or market value. Governments commonly use this approach for standardized bulk commodities, agricultural products, and industrial materials where quantity is easily measured but value can be difficult to assess.

Examples of specific tariffs include:

The U.S. government charges $0.51 on every imported wristwatch. This fee applies whether the watch costs $40 or $5,000.

The U.S. imposes $0.25 per kilogram on certain types of imported steel. A 10,000-kilogram shipment incurs a $2,500 tariff, regardless of steel price fluctuations.

The European Union applies a €100 per ton tariff on wheat imported from non-EU countries.

Specific tariffs offer predictable costs for importers, which helps with financial planning. Their main disadvantage is that protection varies inversely with price. A fixed-fee tariff has a much larger relative impact on low-cost goods than expensive ones.

For example, a $1,000 specific tariff represents a 5% tax on a $20,000 vehicle but only a 2.5% tax on a $40,000 vehicle, providing less protection to domestic producers of higher-end cars.

Compound Tariffs: A Hybrid Approach

A compound tariff combines both percentage-based and fixed-fee elements, applying both to the same imported product. This hybrid approach allows governments to regulate trade based on value while ensuring stable revenue based on quantity.

Examples include:

An imported television might face a duty of $20 plus 5% of its value.

Certain imported footwear faces a 5% tariff plus $1 per pair.

A shipment of 1,000 pairs of shoes valued at $50,000 would face a total tariff of $3,500: $2,500 (5% of $50,000) plus $1,000 ($1 per pair).

Governments often apply compound tariffs to manufactured products made with raw materials that are themselves subject to tariffs. The specific portion can neutralize the cost disadvantage that domestic manufacturers face from paying tariffs on imported raw materials, while the percentage portion protects the finished good.

Why Governments Impose Tariffs

Governments use tariffs to achieve a mix of economic and political objectives. These goals have shifted in priority throughout history, but they generally fall into three main categories: protecting domestic industries, generating revenue, and advancing foreign policy objectives.

Protecting Domestic Industries

The most frequently cited modern justification for tariffs is protecting domestic industries from foreign competition. By making imported goods more expensive, tariffs create a price advantage for locally made products. This encourages consumers and businesses to buy domestic goods, which can strengthen the local economy, encourage domestic investment, and safeguard jobs in protected sectors.

A classic version of this argument is the infant industry theory. This holds that new, developing industries cannot realistically compete with large, established, and more efficient industries in other countries. Proponents argue that temporary tariffs can provide these “infant” industries with a protected domestic market, giving them time to grow, improve their processes, and achieve economies of scale.

Once the industry matures enough to compete globally, the protective tariffs can be removed. Countries like the United States and Germany used high tariffs during their industrial revolutions to shield their developing industries from more established British competition.

Generating Government Revenue

Historically, tariffs were critical for U.S. federal government funding. Throughout the 19th and early 20th centuries, customs duties financed a substantial portion of government operations, sometimes accounting for over 90% of all federal revenue.

However, tariffs as a primary revenue source have diminished dramatically in the modern era. The pivotal shift occurred with the Underwood Tariff Act of 1913, which simultaneously lowered tariff rates and instituted the modern federal income tax. Since then, income and payroll taxes have become the dominant sources of federal revenue.

For context, in fiscal year 2024, the U.S. collected $77 billion in tariffs, representing only about 1.57% of total federal revenue. While recent tariff actions in 2025 have led to projections of much higher collections, potentially over $300 billion, this amount still constitutes a small fraction of the government’s overall income.

Advancing Foreign Policy and Securing Leverage

In today’s global economy, tariffs are most often used as an instrument of foreign and trade policy. They can be deployed strategically to:

Exert economic leverage over other nations to influence their political decisions or retaliate against perceived hostile actions.

Serve as a negotiating tool to pressure other countries to lower their own trade barriers, with the goal of achieving reciprocal market access.

Respond to unfair trade practices, such as “dumping” (when a foreign company sells goods in the U.S. at a price below their cost of production) or the use of government subsidies that give foreign firms an unfair advantage.

Address national security concerns. Tariffs can ensure the U.S. maintains domestic production capacity for critical materials like steel, aluminum, or semiconductors, reducing reliance on potentially unreliable or adversarial foreign suppliers.

The evolution in tariffs’ primary purpose explains a fundamental shift in American governance. In the 19th century, when tariffs were mainly about raising revenue, their creation was a core domestic tax issue—a power the Constitution explicitly gives to Congress. However, as the income tax replaced tariffs as the main revenue source, their function changed.

In the 20th century, trade policy became deeply intertwined with foreign relations and national security—domains where the executive branch can act more quickly than Congress. Recognizing this, Congress began to delegate its tariff-setting authority to the President through a series of laws, empowering the White House to use tariffs as a flexible tool for negotiation and to respond rapidly to foreign policy challenges.

The Economic Impact Debate

The economic effects of tariffs generate intense debate. Proponents argue they are necessary to protect domestic industries and workers, while opponents contend they harm consumers and the broader economy.

The Case For Tariffs

Advocates emphasize tariffs’ role in defending the domestic economy. The core argument is that tariffs provide protection for domestic industries, particularly those struggling to compete with cheaper foreign imports. This protection is intended to spur domestic production, encourage investment in new plants and technology, and create or save American jobs.

For instance, supporters of recent steel tariffs point to over $10 billion in commitments from companies to build new U.S. mills as evidence of their success in stimulating domestic investment.

Tariffs are also presented as a tool to combat unfair trade practices. Proponents argue they can level the playing field when foreign competitors benefit from government subsidies or engage in “dumping”—selling products in the U.S. market at artificially low prices.

A key argument revolves around national security. Maintaining domestic production capacity in strategic sectors like steel, aluminum, and pharmaceuticals is seen as essential to reducing dependence on foreign suppliers, which could become critical in a national emergency or geopolitical crisis.

The Case Against Tariffs

Critics argue that tariffs’ economic costs far outweigh their benefits. The most direct and widely felt negative impact is higher prices for consumers. Economic studies consistently show that the cost of a tariff is not absorbed by the foreign exporter but is instead passed on almost entirely to domestic consumers and businesses.

Recent analyses of tariffs implemented in 2025 project they will raise the overall price level in the U.S. by 1.7% to 2.3%, costing the average American household between $2,300 and $3,800 annually in lost purchasing power.

Another major drawback is the harm tariffs cause to other domestic industries. While tariffs may help producers of a specific commodity like steel, they hurt the far larger number of businesses that use that commodity as a raw material. Automakers, construction companies, and appliance manufacturers all face higher input costs, which can lead to lower profits, reduced investment, and job cuts.

A Federal Reserve study on the 2018 steel tariffs found that while they may have led to an increase of 1,000 jobs in the steel industry, the higher input costs were associated with 75,000 fewer jobs in the broader U.S. manufacturing sector.

Tariffs often provoke retaliation from trading partners. When the U.S. imposes tariffs, other countries frequently respond with their own tariffs on U.S. exports, targeting key sectors like agriculture and manufacturing. This can escalate into a “trade war,” a lose-lose scenario characterized by disrupted supply chains, reduced global trade, and slower economic growth for all nations involved.

Multiple economic analyses conclude that the net effect of tariffs is a drag on the economy, leading to lower GDP, reduced productivity, and higher unemployment over the long term.

Who Really Pays for Tariffs?

While the importing company physically sends the tax payment to the government, the economic burden of the tariff does not typically fall on them or the foreign exporter. Instead, the cost is almost entirely passed through to domestic businesses and, ultimately, to American consumers in the form of higher prices.

This price increase functions as a regressive tax, meaning it disproportionately harms low-income households. Lower-income families spend a much larger percentage of their budget on essential goods like food, clothing, and shoes—items that are often subject to tariffs.

For example, households in the lowest income quintile spent an average of 32.6% of their after-tax income on food in 2023, compared to just 8.1% for households in the highest quintile. Economic modeling of 2025 tariffs projected annual income losses of $1,200 to $1,700 for households at the bottom of the income distribution.

The use of tariffs also creates a fundamental conflict within the domestic economy. The decision to protect an “upstream” industry that produces raw materials, like steel, directly harms the “downstream” industries that consume those materials, like auto and appliance manufacturing.

When the government imposes a tariff on imported steel, it makes both foreign and domestic steel more expensive for U.S. companies. An automaker or construction firm facing higher steel costs must choose between absorbing the cost (reducing profits and investment), passing the cost to consumers (making cars and homes more expensive), or reducing production and employment.

This dynamic reveals that protectionism is not a simple “us vs. them” issue between countries, but a complex “us vs. us” issue that pits different sectors of the American economy against one another, often leading to a net negative outcome for the nation as a whole.

Who Sets Tariffs in the U.S.?

The authority to set tariffs in the United States is a power shared between Congress and the President, though the balance has shifted dramatically over time.

Constitutional Foundation: The Power of Congress

The U.S. Constitution, in Article I, Section 8, explicitly grants Congress the power “To lay and collect Taxes, Duties, Imposts and Excises” and “To regulate Commerce with foreign Nations”. For the first 150 years of the nation’s history, this meant that Congress set specific tariff rates on individual products directly by passing legislation.

The Great Delegation: Shifting Power to the President

A major turning point came in the 1930s amid the Great Depression. With the passage of the Reciprocal Trade Agreements Act of 1934, Congress began to delegate significant tariff-setting authority to the President. This act empowered President Franklin D. Roosevelt to negotiate bilateral agreements to lower tariffs, a move intended to revive the collapsed global trading system.

Since then, Congress has passed numerous laws that grant the President and the executive branch the authority to adjust tariffs under specific circumstances. This delegation of power has been consistently upheld by the Supreme Court, which has ruled that it is constitutional as long as Congress provides an “intelligible principle” to guide the President’s actions.

Key Presidential Authorities in the Modern Era

Today, the President can impose tariffs using several key statutory authorities.

Section 232 of the Trade Expansion Act of 1962: This statute allows the President to adjust tariffs on any imports that are found to “threaten to impair the national security”. The process requires an investigation by the Department of Commerce, which then reports its findings and recommendations to the President. The President has the final authority to decide whether to act. This was the legal basis for the tariffs on steel and aluminum imposed in 2018 and increased in 2025.

Section 301 of the Trade Act of 1974: This law grants the Office of the U.S. Trade Representative broad authority to investigate and take action against foreign trade practices that are considered “unjustifiable,” “unreasonable,” or “discriminatory” and that burden or restrict U.S. commerce. Actions can include imposing tariffs. This was the primary authority used for the large-scale tariffs imposed on Chinese goods related to intellectual property theft and forced technology transfer.

International Emergency Economic Powers Act (IEEPA) of 1977: This powerful act gives the President the authority to regulate a wide range of international economic activities, including imposing tariffs on imports, after declaring a national emergency in response to an “unusual and extraordinary threat” to the nation. This was the authority invoked to impose the broad “Liberation Day” tariffs in 2025.

How the U.S. Classifies and Collects Duties

The process of applying and collecting tariffs is a highly structured administrative operation involving a detailed rulebook and several key government agencies.

The Rulebook: The Harmonized Tariff Schedule

The master document governing all U.S. tariffs is the Harmonized Tariff Schedule of the United States (HTS). This is the official, comprehensive list that contains the applicable tariff rates for every category of merchandise imported into the U.S.

The HTS is a massive and complex document, comprising 99 chapters that classify every conceivable product, from live animals and vegetables to chemicals, textiles, machinery, and works of art. It is based on the international Harmonized System, a global product nomenclature maintained by the World Customs Organization, which ensures that most countries use a common framework for classifying goods in world trade.

The HTS uses a 10-digit code to classify each product with a high degree of specificity. For example, the HTS code 8517.13.00.00 is the specific classification for imported smartphones. Importers are legally responsible for correctly classifying their goods according to this schedule when they declare them to customs.

The HTS is published and maintained by the U.S. International Trade Commission (USITC) and is publicly available on its website.

The Players: Key Agencies and Their Roles

Several federal agencies play distinct and crucial roles in the U.S. tariff system:

U.S. International Trade Commission (USITC): This independent, bipartisan, quasi-judicial agency has two main roles. First, it is the official publisher and maintainer of the Harmonized Tariff Schedule. Second, it conducts investigations into trade issues, such as determining whether a domestic industry has been seriously injured by a surge in imports under Section 201 of the Trade Act of 1974.

U.S. Customs and Border Protection (CBP): As an agency within the Department of Homeland Security, CBP is on the front lines of trade enforcement. It is the only agency with the legal authority to provide binding rulings on how to classify imported goods under the HTS. Its officers at U.S. ports of entry are responsible for inspecting goods, verifying their classification and value, and collecting the duties owed.

Office of the U.S. Trade Representative (USTR): Part of the Executive Office of the President, the USTR is the country’s chief trade negotiator. This office is responsible for developing and coordinating all U.S. international trade policy and takes the lead on Section 301 investigations into unfair foreign trade practices.

Department of Commerce: This cabinet-level department, specifically its Bureau of Industry and Security (BIS), is responsible for conducting the national security investigations required under Section 232 of the Trade Expansion Act. The findings of these investigations form the basis for a presidential decision on whether to impose tariffs on national security grounds.

A Brief History of U.S. Tariffs

The current debates over tariffs are part of a long and cyclical history of trade policy in the United States, which can be broadly divided into three distinct eras.

Three Major Eras of U.S. Tariff Policy

Economic historians typically classify U.S. tariff history into three periods:

The Revenue Period (c. 1790–1860): In the early years of the republic, tariffs were the lifeblood of the federal government. They were the primary source of revenue, often accounting for more than 90% of federal income, and were essential for funding the nation’s operations and paying its debts.

The Restriction Period (1861–1933): After the Civil War, the focus of tariffs shifted from revenue to protection. High protective tariffs became the norm, with average rates frequently exceeding 40%. This policy was designed to shield America’s burgeoning industries from foreign competition and foster the nation’s growth into an industrial powerhouse.

The Reciprocity Period (1934–Present): This era began as a reaction to the disastrous effects of the Smoot-Hawley Tariff. With the Reciprocal Trade Agreements Act of 1934, the U.S. embarked on a long-term policy of lowering tariffs through negotiated agreements. This period saw the creation of the post-World War II global trading system (GATT, and later the WTO) and a general trend toward trade liberalization, which saw average U.S. tariff rates fall to historic lows of around 5% by the end of the 20th century.

Pivotal Moments and Case Studies

Two pieces of legislation stand out as critical turning points in U.S. tariff history.

The Underwood Tariff Act of 1913: This Progressive Era law represented a fundamental break from the high-tariff policies of the late 19th century. It significantly lowered average tariff rates from around 40% to 26%. More importantly, to compensate for the lost revenue, the act implemented the modern federal income tax, made possible by the recent ratification of the 16th Amendment.

This act permanently altered the financial structure of the U.S. government, shifting its reliance from trade taxes to income taxes and transforming tariffs from a primary revenue tool into a secondary policy instrument.

The Smoot-Hawley Tariff Act of 1930: A Cautionary Tale: Perhaps the most infamous tariff law in U.S. history, the Smoot-Hawley Act was signed by President Herbert Hoover in June 1930, just as the Great Depression was taking hold. The act raised import duties on over 20,000 goods to historically high levels, with an average rate approaching 60% on some items.

The intention was to protect American farmers and factory workers from foreign competition. The result was a global economic catastrophe. More than 1,000 economists signed a petition urging President Hoover to veto the bill, warning of its dire consequences. Their predictions proved accurate.

U.S. trading partners swiftly retaliated with their own punishing tariffs on American goods. The ensuing trade war caused global trade to collapse, plummeting by an estimated 65-66% between 1929 and 1934.

Economists and historians widely agree that while the act did not cause the Great Depression, it significantly worsened its severity and duration. Today, Smoot-Hawley serves as the primary historical cautionary tale about the dangers of widespread protectionism and retaliatory trade cycles.

Current U.S. Tariffs (as of 2025)

The U.S. tariff landscape in 2025 is highly dynamic and complex, characterized by multiple layers of tariffs imposed under different legal authorities. The most significant actions involve broad tariffs on goods from China and on steel and aluminum imports globally.

The U.S.-China Trade Relationship: A Complex Web of Tariffs

The tariff situation between the United States and China is not a single tariff but a complex layering of several distinct actions. As of mid-2025, the effective average U.S. tariff rate on Chinese goods is over 50%, a result of multiple tariffs being stacked on top of one another. In response, China has implemented its own multi-layered retaliatory tariffs on U.S. goods, targeting products like soybeans, liquefied natural gas (LNG), and automobiles.

Section 232 Tariffs on Steel and Aluminum

In June 2025, the U.S. government increased the tariff rate on most imported steel and aluminum to 50%, using Section 232 national security authority. The stated rationale was to protect domestic producers from global overcapacity and ensure the U.S. can meet its defense and critical infrastructure needs in an emergency.

The impact of these tariffs clearly illustrates the economic trade-offs involved:

For Steel and Aluminum Producers: The domestic metals industry has largely supported the tariffs, arguing they are necessary to combat unfair foreign competition and stabilize the industry. This has reportedly led to increased investment in domestic production capacity.

For Steel and Aluminum Consumers: Downstream manufacturing industries have been “alarmed” by the tariffs. Sectors like automotive, construction, and food and beverage (which use steel and aluminum cans) face significantly higher material costs. These costs are expected to drive up consumer prices for a wide range of goods, including cars, appliances, canned foods, and even new homes.

Recent Revenue and Economic Projections

The aggressive use of tariffs in 2025 has led to a surge in government revenue from customs duties. The U.S. Treasury reported collecting $100 billion in tariffs by early July 2025, with projections that the full-year total could exceed $300 billion. Data from the Federal Reserve Bank of St. Louis confirms a sharp spike in customs duties collected during this period.

Despite these revenue gains, independent economic analyses project significant negative consequences for the broader U.S. economy.

The Yale Budget Lab estimates that the 2025 tariffs will reduce long-run U.S. real GDP by 0.4%, cause the unemployment rate to rise by 0.4 percentage points, and result in a net loss of 538,000 jobs.

The Penn Wharton Budget Model projects an even larger long-run GDP reduction of approximately 6% and a decrease in wages of 5%. The model calculates that the tariffs would result in a lifetime financial loss of $22,000 for the average middle-income household.

A Federal Reserve analysis concluded that broad-based U.S. tariffs would lead to significant GDP losses for both the U.S. and its trading partners, with the U.S. potentially experiencing a decline of 3.6% in a scenario with broad tariffs but no foreign retaliation.

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