4.1 The Meaning, Importance, and Types of Tariff

What Is a Tariff?

A tariff is a tax charged on a product that is either imported or exported. Export tariffs are used considerably less than import tariffs and are mostly imposed by developing countries as a means of generating government revenue. For instance, exports of key primary agricultural and other commodities from developing countries have been taxed to raise revenue or to improve the terms of trade. Import tariffs have been much more prominent and, therefore, our discussion in this chapter will focus on the economic effects of import tariffs.

An import tariff is a tax that is imposed on an imported product and is collected by customs officials before the shipment is allowed into the country. As with an export tariff, an import tariff can be used to raise government revenue. However, an import tariff is perhaps most often used to protect domestic producers from import competition. We can, therefore, distinguish a revenue tariff from a protective tariff. A revenue tariff aims to generate revenue and may be applied to either exports or imports. A protective tariff aims to reduce the quantity of imports into a country and protects import-competing domestic producers from foreign competition. At present, developing countries rely considerably more on tariffs for revenue than developed countries, as shown in Table 4.1.

Types of Import Tariffs

There are different types of import tariffs. We distinguish three types of tariffs – specific, ad valorem, and compound. A specific tariff is stated in terms of a fixed amount of money per unit of the imported product (e.g., $5 per bottle of wine). An ad valorem tariff is stated as a fixed percent of the value of the imported product (e.g., 5% of a $500 watch). Last, a compound tariff is a combination of specific and ad valorem tariffs.

A specific tariff is easy to administer, particularly for standardized products – for every unit of the product entering the country, the specified level of tariff is charged. One implication of this type of tariff is that the amount of protection for domestic producers varies inversely with changes in the price of the imported product. As the import price rises, the degree of protection provided to domestic producers falls in relative terms. In contrast, a specific tariff provides greater protection during a global recession when the prices of imported products usually weaken.

An ad valorem tariff is more appropriate for manufactured products for which there can be many different versions. As a percent of the value of a product, an ad valorem tariff takes account of the differences in product varieties as reflected in the prices of the imported product. In addition, in contrast to specific tariffs, ad valorem tariffs provide steady protection to domestic producers in the face of changing prices. However, a major drawback with using ad valorem tariffs is that determining the value of the imported product can be difficult because customs appraisers may disagree on value, the price may change frequently, and the basis for valuation (i.e., whether or not to include transportation and insurance) may vary. (See summary in Table 4.2.)

Compound tariffs are often used in the case of manufactured products which contain inputs that are also subject to import tariffs. The specific part of the tariff is intended to offset the cost disadvantage faced by domestic producers that might result from tariff protection provided to domestic suppliers of inputs and the ad valorem part of the tariff provides protection to the finished product itself. The specific part of the tariff, in effect, serves to compensate domestic producers for the higher production costs that they face due to the tariff on imported inputs. Table 4.3  shows the weighted average import tariff rates for selected countries in 2015, indicating relatively low tariffs in advanced countries (e.g., Canada, Germany, the United States).

Effective Rate of Protection

The actual rate of protection that domestic producers receive may be different from the nominal tariff rate on the imported product. So far, we have assumed that a product that is granted import protection is produced fully within the country using only domestic inputs. For instance, a Canadian product is made entirely with Canadian labour and other inputs. However, when some inputs used in making the final product are imported, the degree of protection provided to domestic producers is influenced not only by the nominal tariff rate on the final product but also on any nominal tariffs on imported inputs needed to produce it. Therefore, the nominal tariff on the imported product may differ from the effective tariff rate.

The effective tariff rate considers not only the nominal tariff rate on the imported product but also any tariff imposed on the imported inputs that are used in producing the final good. A nominal tariff on the final product will provide greater protection from imports if the tariff on the imported inputs is relatively low. Since a tariff on imported inputs is a tax on domestic producers of the final product, it increases their cost of production. Therefore, the higher the tariff on imported inputs, the greater the increase in domestic production costs and the lower the effective rate of protection for any given nominal tariff on the final product. National governments typically allow inputs to enter the country either duty-free or at lower rates than those on finished products in order to provide significant protection to their domestic producers.

The effective tariff rate measures the percentage increase in domestic production activities (i.e., value-added) per unit of output that is facilitated by nominal tariffs on both the final product and imported inputs (Carbaugh, 2015). We can calculate the effective tariff rate as follows:

[latex][(v' - v)/v]*\text{100}[/latex]

where [latex]v[/latex] is a unit value added before the tariff on imported inputs is applied, and [latex]v'[/latex] is a unit value added after the tariff on imported inputs is applied (Pugel, 2020).

An example of the calculation of the effective tariff rate is shown in Table 4.4.

References

Carbaugh, R.J. (2015). International economics, (15th ed.). Cengage Learning, 2015.

Pugel, T. A. (2020). International economics, (17th ed.). McGraw-Hill, 2020.