How do tariffs work monetarily?

In My Humble Opinion
1

(Posting this in IMHO because I suspect answers will involve some speculation.)

I will readily admit that I’m pretty ignorant when it comes to tariffs, so please educamate me. I know that tariffs are partly political actions, but I’m curious about the monetary side of them.

Suppose Country A produces doohickeys and is globally the only source for doohickeys. It exports $1 billion worth of doohickeys to Country B. What is this $1 billion? My initial guess is that it’s what the Country B importers pay for the doohickeys, but I’m aware that when it comes to tariffs, sometimes it might be politically more advantageous to state this as what the doohickeys are estimated to actually sell for to consumers. Or maybe even state it as something akin to the MSRP, which – let’s face it – is usually somewhat higher than the actual sales price.

As an example, say that the importer pays $40 for each doohickey. The importer sells them to wholesalers for $45 each. The wholesalers repackage them and sell to retailers for $60. The retailer puts up a sign that says “Doohickeys! Valued at $120. On sale to our customers for only $100!” (If these values which I totally made up are wildly off, please correct.)

Now say that Country B imposes a 25% tariff on the doohickeys. I would assume that regardless of what value is stated for the doohickeys imported from Country A by Country B, the tariff is actually set at 25% of the amount the importers pay for the doohickeys. So the importer now pays $50 for each doohickey. Does the importer typically sell them to the wholesaler for $55, keeping his profit margin at $5, or does he sell them $56.25, keeping his profit margin at 12.5%?

What would you expect the consumer to actually pay for a doohickey – $110, so that the $10 tariff is covered, or $125, maintaining the 25% level of the tariff? In either case, doesn’t the tariff essentially come down to a special federal sales tax on doohickeys?

I would assume that at either retail price the demand for doohickeys would taper off a bit with the increased price. Just to throw a number out there, let’s say that pre-tariff, Country B imported 25 million doohickeys, and post-tariff imports only 20 million. If the tariff works out to $10 per unit, Country B gets $200 million in tariffs.

What happens to this money? I assume it goes into the general revenue pot for Country B. Can Country B now crow about how its deficit isn’t growing nearly as quickly as some had claimed it would, conveniently ignoring the fact that it has essentially raised taxes?

I said at the beginning that Country A is the only source for doohickeys. If it isn’t (and it’s pretty likely not to be), won’t Country B just import more doohickeys from Country C and Country D? (I realize that Country B is probably hoping that doohickeys can now be produced domestically at a competitive price, but that isn’t always possible.) Assuming Country C and Country D have the same production cost per doohickey as Country A, won’t Country C and Country D raise their prices enough that they will be more profitable but still be cheaper than Country A’s price including the tariff? In that case, won’t the consumers in Country B be essentially underwriting profits for Country C and Country D?

2

You seem to me to have a handle on it. The basic question is: what does the importer do? That depends on what the market can bear.

If there’s a strong demand for doohickeys, the importer may be able to add the entire price of the tariff to the doohickeys, so ultimately the price to the consumer goes up proportionately, as each step in the supply chain the import duty affects the mark-up.

But if there’s a weak demand, the importer may not be able to pass along the entire import duty. Probably would pass some along, but may not be able to pass the whole increase.

Or, the importer may try to find doohickeys to import from some other country at a cheaper price. That may be an option, even if the cheaper doohickeys aren’t such good quality.

Money from tariffs normally go into general government revenues, unless they’ve been specially allocated by statute to a specific purpose.

Your example of the collateral effect on Countries C and D are one possibility. But C and D may choose to keep their prices low, even though A’s doohickeys are having duty levied, because in the short to medium run, that might drive the doohickeys from country A out of the markets in country B entirely, or even drive the A doohickey makers out of business.

All of these options are why economists generally don’t like nation-specific tariffs. They have a considerable distorting effect on market prices and market behaviour.

And that’s all I’ll say to keep out of GD territory. :wink:

3

Thanks, Northern Piper. I kept asking myself what I was missing in my understanding of tariffs since I couldn’t understand the rationale for tariffs against one country.

You cut your answer down so it didn’t drift into GD territory. I had to be circumspect in my question to keep it out of the Pit. Maybe I’ll post something there about tariffs now that I’m assured my understanding of how they work isn’t too off the mark.

4

A few quick answers, based on my observations and past reading of how things work:

“What is this $1 billion?” That’s the pre-tariff cost paid by the importer. So 25,000,000 doohickeys at $40 contract price is $1 billion. The $250 million tariff is a separate cost. Finished goods may have a higher final retail price, and that retail price may be what’s used in calculating the cost to consumers, but the listed amount of imports should be the amount paid to the exporters.

“Does the importer typically sell them to the wholesaler for $55, keeping his profit margin at $5, or does he sell them $56.25, keeping his profit margin at 12.5%?” Initially, the price will probably be somewhere between the original $45 and just above $50 while the importer tries to figure out where his price point should be. The importer is going to try to avoid losing money, but also try to maintain as much sales volume as possible. It’s better to take a short-term profit hit than to lose customers. On the other hand, maintaining volume while selling at a loss is not a good long-term idea, so the onward sales price will eventually go up.

“Doesn’t the tariff essentially come down to a special federal sales tax on doohickeys?” Yes.

“What happens to this money? [from the tariffs]” This is very much my opinion. It depends on how well planned the tariffs are, what the government is trying to accomplish with the tariffs, and how the revenue from the tariffs is redirected. If the aim of a tariff is simply political, the money is going to go into the general fund, and the government has imposed a tax on consumers of doohickeys. It’s an overall economic cost traded off for a political gain. If the tariff is meant to be rebalancing a sector of the economy, then the money should go towards repurposing that sector of the economy. So the money gained on a tax on steel imports should either be spent on research and development to make the steel industry globally competitive, or on redirecting workers to new industries besides steel. Simple price support through tariffs without intervention is just delaying decline at an overall cost to the economy. If the aim of tariffs is to raise funds, then that tax should be counter-balanced by the removal of less efficient taxes, infrastructure investment, or deficit reduction. It should be viewed as a trade-off between an economic cost and offsetting economic gains. Ideally a package of tariffs will try to balance all of these objectives and generate a net gain. However, the use of any economic lever, including tariffs, will have uncertain outcomes and should be considered with caution.

“Won’t Country C and Country D raise their prices enough that they will be more profitable but still be cheaper than Country A’s price including the tariff?” Probably, yes. In supply and demand terms, the number of suppliers willing to supply doohickeys at a given price has been reduced. The supply curve has moved left, and therefore prices should increase.

5

In the long run, the answer is likely that every party in the transaction takes some of the hit from the tariff due to supply and demand curves.

So, the importer will lower his profit margin some, the wholesaler and the retailer will too, and some customers will not buy as many widgets because they don’t think they’re worth the cost. Additionally, the manufacturer will likely lower their margins. Everyone loses a little bit.

There are some cases where certain participants have more market power and can force others to accept more (or all) of the tax burden. There are also some weird cases where the supply and demand curves do odd things, which can have some odd and unintuitive results, but they are pretty rare.

6

Tariffs are levied on the FOB value of the goods, even if the commercial bills/invoice quotes INCO terms like CIF or FIS or ex works etc.
(there’s a whole lexicon of chargesassociated with international trade and at what point the transaction risk transfers from seller to the buyer.)

Also for tariff purposes the FOB value is quoted in domestic currency, even if the goods are purchased in the selling countries currency, or a third currency.

If Country A exports $1 billion doohickeys then in it’s national accounts as the value as FOB.

Apples v apples then when Country B reports that it imports $1 billion doohickeys then that should be the FOB expressed in domestic currency. No margins or on-costs.

The landed cost of dookickeys includes the FOB, freight, insurance, domestic customs and import handling costs and typically financing.

7

There are domestic doohickey manufacturers who tended to sell to wholesalers at 48-55 bucks, but not that many units, because cheaper ones were available to wholesalers (and in the end, consumers) at cheaper pricing from imports. These domestic produces now will sell more units, and the delta between original (and now no longer available) imported doohickey cost and this domestic cost is borne by wholesalers. Retailers,and especially consumers.

8

That’s assuming there are domestic manufacturers of doohickeys. That’s not actually the case, as a lot of US manufacturing has moved off-shore or just ceased production.

Here’s an article that discusses the implications of high tariffs on goods from Country-C. It is somewhat critical of a certain Individual-1, but seems sound on its discussion of the underlying facts and economics.

https://www-cnn.com/2019/05/13/politics/trump-china-tariffs-buy-america-fact-check/index.html?r=https%3A%2F%2Fwww.google.ca%2F

9

Having worked for 20 years in importing in small and medium sized businesses, most of the answers were correct.

Generally, the importer is also the distributor. There really isn’t a need for a separate company simply to bring a product into a country. The distributor can also sell through other wholesalers. The numbers are completely wrong, because the distributor needs a greater price margin.

But rather than try to make the numbers more realistic, we’ll just stay with the model since it’s already there.

In the industries I was involved with, the prices are raised and the companies just try to do the best they can. It doesn’t matter if the additional prices come from tariffs, increased fuel costs, increased prices from the manufacturer, increase costs of this or that, whatever. When the cost to the importer is increased, the sales price needs to be increased as well. We had products which sold well until the manufacture raised prices and we were no longer competitive in Japan. Sometime the pricing just was too much even if there wasn’t a competing product.

While some adjustments are made in individual pricing to reflect competition, in general the same profit margins are kept. So, in my former industry, the product would sell at $125 and if the market wouldn’t accept that, then you would find another source or even just abandon that product line.

In very simple terms, profit is calculated in percentages. It needs to because the cost of doing business increases with greater volume. In this example, there will be more warehouse space and increased labor costs.

Companies often have minimum gross profit targets related to their IRR and will drop products, product lines or business which fall below this. Mega corporations will often spin off divisions which are profitable but the IRR is below the corporate goals.

Northern Piper’s link is broken. Here is the correct one.

10

The term in economics for that question, that others have basically described, is tax incidence. The question is really about the individual market. With tariffs the question is harder since the tax varies based on where the manufacturer is based. The edge cases where either the seller or buyer pay all of the tax aren’t the norm.

It’s a useful term to remember because it’s widely misunderstood. Frequently people seem to pay attention to who’s being taxed and ignore how much of that can or will be borne by the other parties in the market. Who cuts the check to the government isn’t really part of answering the question of who really pays.

11

Thanks for fixing the link, Tokyo Bayer.

12

Basically correct, but there are a lot of complex questions. Ad Valorem are placed on FOB values but for alcohol it can be placed on the alcoholic content. That applies to Excise tariffs as will as import tariffs. There may also be agreements between certain countries where tariffs may be applied to say Japan, but not the UK.

In Australia, there was also something we had called Primage duty- essentially an extension of tariffs- which has thankfully long gone. There are also tariff concessions where if certain goods are not manufactured there maybe a concession where the non manufacured widget is not taxed (There was a certain area where a tariff concession could be applied if the area was murky and there were certain “gifts”).

However bottom line is if it is a level field- seldom- and all countries are treated the same (ha)- it is an ad valorem tax on Free On Board price of the goods. So if I could get a car from Japan and also from Germany I would (or the importer) be paying the same amount of import tariff. You decide which one you want more or is the better quality.

Of course there can also be sales tax which increases on a more expensive car- or even tariff quotas.

13

Things turn out to be much more complicated than what is taught in basic business or economic classes. There are too many variables, including the relationship between the distributor and manufacturer, if the importer/distributor has an exclusive relationship or not, what other product lines there are, etc.

In general, importers/distributors have less incentive to take even short-term hits to profits. Manufacturers only have that product line, so they are stuck with it but importers/distributors have to protect their money.

14

What happens when the goods have already been sold before the tariff was imposed?

This has been a topic in board game groups. There are a lot of games that are funded on Kickstarter. The game designers collect the money at the beginning of the project, spend a year or so developing and producing the game, and then deliver them to the buyers when they’re ready.

But a lot of these games are being manufactured in China. What happens when you collect money for a product in August 2018 in order to deliver it in August 2019 but then a tariff is imposed in April 2019? You can’t raise the price to cover the tariff costs; the buyer has already bought the product. Are companies expected to just suck up the tariff costs as a loss?

What happens if they can’t? A lot of board game companies are pretty small and marginal businesses. If you hand them a tariff bill for $20,000, they might legitimately say they don’t have $20,000. What happens then?

I’m using board games as an example but I’m sure there are many other products traveling down similar pipelines. Do the products get sent back to China or dumped in a government warehouse somewhere or are they tossed in a landfill?

15

I agree that things are much more complicated, and will defer to your personal business experience working for an importer/distributor. I will note though, that for retail brands, market share is a huge driver in pricing decisions. A US company may have a contract with a China manufacturer to make the product they’re going to import and sell on to a retail store. Cost will be a consideration in setting a price, and an increase in import duty represents an increased cost. However, many other factors affect pricing decisions. Here’s a few:
• Competition – will all suppliers of a given product raise their prices? If you’re importing from China, while your competition is importing from Vietnam, you’ve got a hard decision on your hands.
• Existing contracts – can you even raise your prices in the near-term?
• Demand elasticity – if prices rise significantly, will consumers stop buying that product?
• Cost profile – many companies spend far more on marketing than what they pay the manufacturer. Does Nike import from China? If they’ve found a sweet spot in the market, and spent billions in advertising to get to that sweet spot, they might decide to absorb $2.50 for a pair of shoes they’re wholesaling for much more, rather than disturb that sweet spot.
• Product strategy – raising prices is a normal business activity. Often it’s disguised as a product change. So kitchen appliance 2018 is due to be replaced by the new and improved kitchen appliance 2019 in just a few months. Bump up the prices later when it’s not apparent to the consumer, rather than immediately.

Again, if costs rise, prices will generally also rise, especially in the long term. But for many businesses, especially suppliers of name brand retail products, price is not some automatic multiple of cost. Many other factors go into setting a price, and businesses will often take time to consider those factors before adjusting their prices.

16

I am far more experienced in traded goods and commodities but think it’s the same situation as if you travelled to China yourself, bought your own doohickey at the factory shop and then shipped it back stateside via parcel post.

You’d need to make an import declaration and if a tariff was applicable you would be billed.

The question is of risk, if you have taken ownership of the goods, the risk is yours.

All of those options would probably be way more costly than the tariff.

17

About 20 years ago, there was a financial crisis in Southeast Asia. Local currencies experienced some serious declines against the dollar. At the time, I was working for a Japan importer/distributor and worked with many US and European manufactures.

The Indonesian currency lost 25% in one day. One day. You simply can’t do business in that circumstance because you are buying in dollars and selling in the local currency. Many companies went out of business.

For the question about Kickstarter board games, in a general case what happens to companies who are unable to deliver? Do they return the money? Are the customers screwed? That has to be keeping a lot of people up late at night.

Unless the companies are being run by absolute idiots, the order shouldn’t be placed in the first place.

I don’t know what the actual procedure if is tariffs can’t be paid. It could be that the freight forwarder or carrier takes possession of it. We were always billed by company which handled the products.

Well, yes. I happen to be aware of that.

This was your post.

I can’t see the justification for making such a general statement considering all of the different conditions. Yes, there will be some companies which will eat the entire cost. However, there will be others which will pass it along to the entire cost to the customers. Others will be in between.

No one right now can possibly made anything but a wild-ass guess and how much of the several hundred billions of dollars of new tariffs will fall into which category.

18

That’s not really the issue. If you don’t have enough money to pay the tariff, then the tariff isn’t going to be paid. My question was what does the government do with the good when the tariff on them isn’t paid.

19

With Kickstarter, the customers are pretty much screwed. The company can’t return the money because they no longer have it.

What makes them absolute idiots? Companies place orders all the time. It’s standard business.

20

Is this a scenario where, for example, $80,000 was raised for the game, and a Chinese manufacturer was contracted to manufacture and ship 5,000 units of the game with payment up front?

The important company to consider is the freight company actually shipping the goods across the Pacific. This order is relatively small scale, so the freight company will be acting as the customs broker. They’re going to be the agency making the direct payment ($20,000) to the customs agency. Out of curiosity, I took a look at DHL’s small business offering. It looks like if both the importer and the exporter are DHL customers, DHL will pay the import duties and rebill them to the importer. If the importer is not a DHL customer, then I would assume DHL would require payment for the import duties from the shipper. Which means that the shipper/games manufacturer would then demand the funds from the game designers. If those funds aren’t forthcoming, then most likely the order isn’t shipped and is eventually discarded.