Tariffs Chapter 4 Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

Tariffs

Chapter 4

Copyright © 2009 South-Western, a division of Cengage Learning. All rights reserved.

Tariffso definition – tax levied on a good when it

crosses a national border• import tariff – much more common • export tariff – less common; revenue source

o purposes• protective tariff – designed to reduce the

amount of imports entering a country; increase sales for domestic producers

• revenue generation – designed to generate additional funds for domestic government

Types of Tariffs1) specific tariff – fixed monetary amount per

unit of the imported good

2) ad valorem tariff – fixed percentage of the value of the imported goodcustoms valuation – process of determining the value of an imported goodofree-on-board (FOB) valuation – tariff applied as product leaves countryocost-insurance-freight (CIF)valuation – tariff applied as product enters country

3) compound tariff – combines the elements of specific and ad valorem tariffs

Tariff Examples by Country and Industry

Effective Rate of Protection1) nominal tariff rate – based on tariff applied to

value of finished product

2) effective tariff rate – based on tariff applied to finished product and imported inputs

n = nominal tariff rate on final product

a = ratio of value of imported input to value of finished product (prior to tariffs)

b = nominal tariff rate on imported input

effective rate of protection = e =(n-ab)(1-a)

Effective Rate – 1st Example

e = = = 0.5 = 50%(n-ab)(1-a)

0.1-0.8(0) 1-0.8

for this example:n = $50/($100 + $400) = 0.1 = 10%a = $400/($100 + $400) = 0.8b = $0/($400) = 0

Effective Rate – 2nd Example

e = = = 0.3 = 30%(n-ab)(1-a)

0.1-0.8(0.05) 1-0.8

in this case:n = $50/($100 + $400) = 0.1 = 10%a = $400/($100 + $400) = 0.8b = $20/($400) = 0.05 = 5%

Tariff Escalationo tariff escalation – higher tariffs on intermediate and finished goods and lower tariffs on raw materialso incentive for developing nations to expand production of raw materialso disincentive for developing nations to compete in market for finished goods

Offshore Assembly Provision (OAP)o outsourcing – aspects of production process

occur in another countryo low cost, labor intensive productso OAP – tariffs applied only to portion of

production occurring in another countryo reduces effective tariff rate for domestic

consumerso incentive for foreign producers to use U.S.

components in productiono detrimental to U.S. workers who also produce

the same finished goods

Dodging Import Tariffso tariff avoidance – legal method of reducing or

eliminating the amount paid in tariffs

example: Brazilian raw sugar shipped to Caribbean and refined there into ethanol then imported to the U.S. duty free

o tariff evasion – illegal means of reducing or eliminating tariffs

examples:

false reclassification of products

falsification of country of origin

altering composition of product itself

Postponing Import TariffsBonded Warehouseo location maintained by importers ensuring that

all customs obligations will be satisfiedo goods may be stored for maximum of 5 yearso requires inspection by U.S. Customs Service

Foreign-Trade Zoneo U.S. site at which foreign merchandise can be

imported without immediate payment of duties or tariffs

o does not require inspection by U.S. Customs

Consumer & Producer Surplus 1) consumer surplus – additional benefit

obtained by the buyer of a good• difference between the maximum that the

buyer is willing to pay and the actual price• area below demand and above price

2) producer surplus – additional benefit obtained by the seller of a good• difference between the minimum that the

seller is willing to accept and the actual price• area above supply and below price

Consumer & Producer Surplus (cont.)

When combined, the areas of consumer surplus and producer surplus represent the total welfare to the nation resulting from the sale of this good.

Tariff Welfare Effects – Small Nation Before Trade:U.S. consumer surplus is area in red.

U.S. producer surplus is area in green.

Tariff Welfare Effects – Small Nation With Free Trade:Consumer surplus increases by areas a,b,c,d,e,f and g.

Producer surplus decreases by areas a and e.

The overall increase in welfare is b,c,d and f.

Tariff Welfare Effects – Small Nation With Tariff:c = revenue effect = lost consumer surplus now government rev.

a = redistributive effect = shift from consumer to producer surplus

b + d = deadweight loss = benefits lost to all parties b = protective effect d = consumption effect

Tariff Welfare Effects – Large Nation Before Trade:U.S. consumer surplus is area in red

U.S. producer surplus is area in green.

Tariff Welfare Effects – Large Nation With Free Trade:Consumer surplus increases substantially.

Producer surplus decreases but to a lesser degree.

The overall increase in welfare is b,c,d and the triangle above.

Tariff Welfare Effects – Large Nation With Tariff:c + e = revenue effect = consumer surplus now government rev.a = redistributive effect = shift from consumer to producer surplusb + d = deadweight loss = benefits lost to all parties b = protective effect d = consumption effect above.

Tariff Welfare Effects – Large Nation Revenue Effect:In this case there are two separate portions:

c = domestic revenue effect = prior U.S. consumer surplus

e = terms-of-trade effect = redistribution of income from foreign nation

area e > (b+d) leads to more domestic welfare

Tariff Burdens on U.S. Exporters 1) cost of inputs: tariffs increase price of imported

raw materials thus increasing the price of manufacturing using these materials making U.S. firms less competitive

2) cost of living: tariffs lead to higher prices for U.S. consumers eventually leading to higher wages for U.S. workers

3) international repercussions: tariffs decrease exports from other countries decreasing their income and ability to purchase U.S. exports

Tariffs and the Poor o tariffs often applied to low

price products which represent large share of budgets of low-income households

o regressive - poor pay greater tariffs in percentage terms

o high end domestic producers compete based on prestige and quality rather than price so these producers do not lobby as much for greater protection from imports

Trade Restriction Arguments1) job protection

• preserve jobs in some industries but decrease employment in others

• increased cost to consumer greater than average salary for worker whose job was saved

2) cheap foreign labor• productivity and cost relevant factors• relevant to labor intensive production only

3) fairness in trade – level playing field• other nations lack of environmental regulations• response to trade barriers of other nations

Trade Restrictions Arguments (cont.)4) domestic standard of living

• restrictions only improve standard of living at the expense of trading partners

5) equalized production costs• scientific tariff – tariff to offset cost differentials• subsidizes inefficient domestic production

6) infant industry• short run protection for new domestic industries

against developed foreign competition

7) noneconomic arguments• national defense and cultural considerations

Political Economy of Protectionismo protection-biased sector consists of import

competing companies, their workers, and suppliers to these industries

o free-trade-biased sector consists of exporting industries, their workers and suppliers to these industries

o U.S. policy dominated by well organized special interest groups representing producers

o consumers generally unorganized and diverseo tariff escalation effect as evidence of this

imbalance

Supply & Demand of Protectionismgreater supply of protection:

1) higher cost to society

2) greater political importance

3) higher adjustment costs

4) greater public sympathy

greater demand for protection:

1) greater comparative disadvantage

2) greater import penetration

3) greater domestic concentration

4) lesser export dependence