Understanding Tariffs: How They Work and Why They Matter

Insights April 15, 2025

Key Takeaways

  • Tariffs are taxes on imports that can protect domestic industries but often lead to higher consumer prices.
  • Governments use tariffs strategically—to counter unfair trade practices, support national security, and reduce trade deficits.
  • There are several types of tariffs, including ad valorem, specific, and tariff-rate quotas, each serving different policy goals.
  • While tariffs can benefit certain sectors, they may disrupt supply chains, strain international relationships, and contribute to inflation.

Tariffs—taxes on imports—help shape global trade by influencing prices, protecting domestic industries, and guiding international negotiations. They often make headlines during trade disputes, but their real-world impact is broader and more nuanced.

This guide breaks down what tariffs are, why governments use them, and how they affect economies, businesses, and consumers.

What Are Tariffs?

Tariffs are government-imposed taxes on goods imported from other countries. By increasing the cost of foreign goods, tariffs aim to make domestic products more competitive.

For example, if the U.S. places a 15% tariff on imported clothing from abroad, those items become more expensive in American stores—encouraging shoppers to choose products made in the U.S.

While this can protect local jobs and industries, tariffs can also lead to higher consumer prices and strain international trade relationships.

Types of Tariffs

Governments use different types of tariffs to achieve specific goals, including:

  • Ad Valorem Tariffs: A percentage of the product’s value (e.g., 10% on a $1,000 item = $100).
  • Specific Tariffs: A fixed dollar amount per unit (e.g., $2 per kilogram of cheese, regardless of price). 
  • Tariff-Rate Quotas (TRQs): Allow a set amount of imports at a lower tariff. Once the quota is filled, a higher tariff applies.
  • Variable Tariffs: Adjusts automatically based on global prices—though rare today, they’re still occasionally used in agriculture to stabilize local markets.
  • Protective vs. Revenue Tariffs: Protective tariffs defend local industries, while revenue tariffs (less common today) raise government income. 

Why Do Governments Use Tariffs?

Not all tariffs are created equal. Governments use different types depending on policy goals:

  • Protect Local Industries: Tariffs give domestic producers an edge over cheaper imports, helping them grow and maintain employment.
  • Reduce Trade Deficits: By discouraging imports, tariffs may reduce the trade gap—though long-term effectiveness depends on broader economic factors, such as currency movements and global demand.
  • Generate Revenue: Before income taxes, tariffs were a major source of government income—though they play a smaller role today. 
  • Counter Unfair Trade: Tariffs can respond to practices like dumping or foreign subsidies that undercut fair competition. 
  • Bolster National Security: Tariffs on critical goods (e.g., energy, semiconductors) can reduce reliance on foreign suppliers. 

Economic Impact of Tariffs

Tariffs can support domestic industries—but they often come with trade-offs:

  • Higher Consumer Prices: Businesses usually pass added costs to buyers. Cars, electronics, clothing, and food are common examples. 
  • Shifting Trade Relationships: Retaliatory tariffs can escalate into trade wars, disrupting global commerce and supply chains.
  • Mixed Results for Industry: While some sectors benefit (e.g., U.S. steel mills), others face higher input costs, reducing competitiveness. 
  • Supply Chain Friction: Tariffs can force businesses to rework supply lines, switch suppliers, or relocate production—often at a cost.
  • Inflationary Pressure: Tariffs can drive up prices in import-heavy sectors, even if the overall impact on national inflation is modest.
  • Limited Revenue Gains: In fiscal year 2024, U.S. tariffs generated approximately $80 billion—accounting for only about 1.7% of total federal revenue, which exceeded $4.9 trillion that year.

Pros and Cons of Tariffs

Tariffs are a balancing act between short-term protection and long-term competitiveness.

Pros

  • Support local industries and jobs
  • Encourage domestic production and investment
  • Reduce reliance on foreign suppliers 
  • Address unfair trade practices

Cons

Summary: Are Tariffs Good or Bad?

Tariffs are neither inherently good nor bad—they’re tools. Like any tool, their value depends on how, when, and why they’re used. Used wisely, tariffs can support national priorities and protect vulnerable sectors. Used recklessly, they can raise prices, fuel inflation, and damage global relationships.

For businesses, investors, and consumers, understanding how tariffs work is crucial in navigating today’s interconnected global economy. As supply chains shift and trade tensions rise, expect tariffs to remain a hot topic in both policy and the marketplace. Consulting with a financial advisor can be helpful in making informed decisions about how tariffs and trade policies may affect your investments or business operations.