John Phipps' Tariffs 101: An Explanation of How Tariffs Work

John Phipps' "AgSplainer" on U.S. Farm Report breaks down the fundamentals of tariffs. ( MGN )

Looking over the feedback I’ve received from my comments about the trade situation, I’ve discovered there is some confusion about how tariffs work. So, this week and next, I will outline the fundamentals of tariffs and how they affect international trade.

The first point is simple: Tariffs are taxes. Period. Here’s why.

A factory in the U.S. makes farming machinery, to pick an example completely at random. It goes to buy steel, but has a budget of $100. A steelmaker in the US says, we have steel but it’s $110. A factory in China says, “we’ve got steel and we will sell it for $100,” and the deal gets done.

The U.S. steelmaker complains to our government the Chinese are cheating with subsidies, cheap labor, or other unfair practices. And to the horror of virtually every economist on earth, the U.S. government says we’ll punish China with a tariff. Only watch what actually happens.

The next time the farm machinery maker buys steel from China, he pays a 25% tariff. That’s right, the U.S. buyer pays the tariff to our Treasury. This is identical to a how a sales tax works, folks.

The obvious question is why didn’t he buy the U.S. steel for $110? The answer is because U.S. steelmakers are not stupid. They now can increase their profits without doing anything other than changing the sticker price. They raised their prices to match the tariff. Watch my commentary for a chart of steel prices around the world.

Economists predicted this, and it’s exactly what happened. See if you can pinpojnt when the steel tariffs went into effect. Note this tweet by The Coalition of Metal Manufacturers - domestic steel users: The U.S. is now an “island of high steel prices”.

The big point, which I don’t think our administration understands is the Chinese seller did not pay any tariff, the American buyer did. This is why the No. 1 American Tax hater, Grover Norquist, President of the Americans For Tax Reform tweeted this. I can’t remember when if ever, I have agreed so completely with Mr. Norquist.

Watch U.S. Farm Report next week, as we go on the show how tariffs don’t accomplish the predicted economic and policy goals, and how they arbitrarily make winners and losers here in the U.S. -- or perhaps more accurately losers and bigger losers.


Read the rest of this series

John Phipps' Tariff 102: Do Tariffs Accomplish Policy Goals?

John Phipps' Tariffs 103: Tariffs and Politics