Impacts of Taxes and Tariffs on Imports - Essay Example

Impacts of Taxes and Tariffs on Imports Tariffs can be defined as taxes imposed on goods moving across an economic or political boundary. They can beimposed on imports, exports, or goods in transit through a country on their way to some other destination. In the United States, export tariffs are constitutionally banned, but in other parts of the world they are quite frequent. The most common type of tariff in many nations is import tariff. Import tariffs have a twofold economic effect. First, they have a tendency of raising the price of imported goods and by this means protect domestic industries from foreign competition. Second, they create tax revenues for the governments imposing them. In spite of what the goals are, tariffs may not be the most direct or efficient means attaining them. For instance, foreign sellers may reduce their prices to counteract any tariff increase. The net effect is for the consumer-paid price to be different only to some extent, if at all, from the price before the tariff was imposed. As a result, the nation has larger tariff revenues but slight additional protection for the domestic producers. When tariffs do elevate the price of an imported good, consumers are put at a disadvantage, while the import-competing industries are put at an advantage. On the other hand, tariffs can have wider implications. For example, when the U.S. Department of Commerce imposed a high duty on complex flat screens used on laptop computers, the duty was an advantage to some small U.S. screen manufacturers (Salvatore 2005). But it damaged companies such as Apple, Compaq and IBM, who disagree that the high duty exaggerated the cost of their products, destabilized their ability to compete abroad and forced them to shift production to other countries. This papers looks at the impacts of tariffs or taxes on imports on a large economy (the U.S.) and a small economy (Kenya). Import tariffs may be of the predetermined variety or they may be ad valorem. Characteristically the importing firm pays the tariff as a tax to the government of the importing country. In order to recover the cost of the tariff the importer charges customers a price at least equal to the import plus the tariff. Because of the tariff, the domestic price of the imported item becomes higher than it would have been with free trade. Imposing taxes or tariffs on foreign products is a form of controlling trade; they are enforced by governments for a variety of reasons. One purpose is simply to create revenues. Another purpose is to lessen the competitiveness of foreign products by blowing up prices and making domestically produced goods more attractive. A tariff can be limiting or exclusionary depending on its amount in relation to the price of the incoming product. Often, tariffs are levied on the original selling cost of the product as well as its landed value, which includes insurance and freight charges. This cost, insurance and freight amount can be substantial for goods that are shipped over long distances. A tariff allows consumers to import more in response to changed market conditions, as long as they pay the tariff. When a country imposes an import tariff, four mechanisms are at play; 1. A substitution effect on domestic consumption- Other things held constant, a tariff raise leads to an increase in domestic prices, which reduces domestic consumption of the commodity in favor of other goods. 2. A substitution effect on domestic production- Other things held constant, a tariff raise leads to a domestic price increase which expands domestic production of commodities to the disadvantage of other goods 3. A crash on world price- a tariff raise, by reducing world demand on the commodity, decreases its world price which means that terms of trade are improved for the country importing that commodity (Krugman & Robin 2006). 4. A multiplier effect- A raise in real income, through improved terms of trade, raises the demand for imports, which in turn, boosts tariff receipts, which then enhances real income. In some cases, countries such as the United States use what is known as‘uplift’. When governments enforce uplifts, the affirmed value stated on the custom documents is augmented by an earlier mandated percentage before the insurance and freight value of the product is calculated. The use of uplifts further raises the landed cost and considerably reduces the competitiveness of the imported product in comparison to domestically produced goods (Sexton 2010). In other cases, import regulations, tariffs, and taxes are combined to curb the entry or reduce the competitiveness of imported products. There are a number of methods for examining the effects upon consumption, production and trade of imposing import tariffs or taxes. To explore the effects of an import tariff on a small economy such as Kenya which has a trade volume too small to manipulate international prices, it is simplest to take a two-commodity case. That is the country is a price taker, such that its commodity terms-of-trade are unaltered by the amount of either its imports or exports; the price ratio of exports to imports is therefore in affect fixed by world markets (Carbaugh 2008). Imposition of a tariff on imports of a commodity by Kenya can be represented by an inward shift of its offer curve. The tariff will cause the domestic price of the imported commodity to rise. This will have a number of effects such as; domestic demand for the imported commodity will go down some domestic resources will be switched from production of the exported commodity to facilitate domestic production lower production of commodity will lead to condensed exports In terms of trade, the anticipated cumulative effect of imposing an import tariff will be a fall in both imports and exports, from the point of view of consumer wellbeing this decrease of trade as a result of a tariff is the reverse of the effect that factor productivity increased has in increasing trade. The decline in imports reflects a limitation of consumption possibilities and, in a purely competitive economy, in a loss of consumer welfare. If the United States (a large economy) which imports a noteworthy proportion of the total traded amount of a commodity were to exact an import tariff it would be anticipated that the terms of trade would incline somewhat in its favor. Reduced demand for the imported commodity would lead to a decrease in the international price: this might also be escorted by a raise in the price of exports caused by reduced export supply availability from the country. To the scope that the tariff results in better terms-of-trade, the welfare loss (to the country imposing the tariff) and trade reduction will be less than if there was no receptiveness in international prices (Ebrill, et al 1999). The effectual tariff rate is a function of the tariffs charged on the component parts and the final product, the technological process concerned, and the relative prices of all inputs into the final product. Analysis of tariff increase using effectual tariff rates demonstrates the effect of the existing tariff structures in many developed countries on the industrial development of small countries. By imposing high tariffs on the output of manufactured goods than on primary products, developed countries are in result imposing considerably higher trade taxes on manufacturing value added in developing countries (Tokarick 2006). Such tariff increase serves to dampen the development of, for instance, food processing in less developed countries (Kenya) since the effective tariff rate on value added in food processing is very high. Such tariff peaks and tariff escalation are obviously unjust and have a predominantly destructive effect on development by restricting industrial diversification in the poorest countries. Figure 2 illustrates the effect of a U.S. tariff of $2 per pound on imported shrimp. Before the tariff is imposed, the price of shrimp under free trade is the world price: $3 per pound. The U.S. imports eight million pounds per year (the distance BC). When the tariff is imposed, U.S. importers have to pay the same $ 3 per pound to their overseas suppliers. But now they must also pay $3 per pound to the U.S. government. Consequently, the price of imported shrimp rises from $3 (p1) to $5 (p2) per pound to cover up for the additional cost of the tariff. The elevated price for imported shrimp allows the U.S. producers to charge $5 for their domestic shrimp as well. As the price of shrimp goes up, local quantity supplied increases (a movement along the supply curve from point F to point A). At the same time, domestic quantity demanded reduces (a movement along the demand curve from point F to Point B). The final result is a decrease in imports from Q1Q4 to Q2Q3. Economists, who usually contest measures such as quotas and tariffs to control trade, argue that, if one of these devices must be used, tariffs are the better choice. While both policies lessen the gains that countries can benefit from specializing and trading with each other, the tariff provides some recompense in the form of extra government revenue. Tariffs are normally imposed in order to defend domestic producers from foreign competition. Governments assess two types of tariffs; revenue and protective tariffs. Revenue tariffs create income for the government. Upon returning home, U.S. leisure travelers who are out of the country more than two days and who carry back goods purchased out of the country must pay taxes on their value in excess of $200 to $1, 600, depending on the country of origin. This duty goes straight to the U.S. Treasury. The main purpose of a protective tariff is to increase the retail price of imported products to match or surpass the prices of comparable products manufactured in the home country. In other words, protective tariffs seek out to restrict imports and level the playing field for local competitors (Tokarick 2006). Of course, tariffs generate a drawback to companies that want to export to the countries that are also imposing tariffs. In addition, governments do not always agree on the reasons behind protective tariffs. So they do not always have the preferred effect. The United States imposes a tariff on foreign competitors accused of selling products at lower prices in the United States that U.S. manufacturers charge. More significantly, the tariff and trade liberalization reforms in Kenya as in the rest of East Africa Community (EAC), do not characterize the real reductions in levels of production. Considerable reversals have been attained by the use of suspended duties in Kenya and partner countries. Increases in tariffs on a wide range of goods have brought an additional 5 to 20%. A significant link in Kenya’s anti-export favoritism and reversals of trade liberalization is their close affinity to early developments within EAC. The potential impact of the EAC was destabilized by the accumulated escalation of the tariff structure in Kenya that was left more or less undamaged after the fall down of the EAC. The structure perpetuated the domestic supply of confined inputs. The requirements were reinforced by declining ‘domestic content’ requirements as well as prevalent import licensing requirements. Set at a flat 20% rebate rate while tariffs on intermediary inputs ranged between 0-80%, the EAC distorted both the levels of incentives and the makeup of investment in exports by over-compensating some exporters and under-compensating others (Dinopoulos 2008). The EAC predisposed Kenya’s choices of policy tools for further protection as well as responses to exterior shocks at the national level. Since common exterior tariffs served to bound independent increases, quantitative restrictions and licensing of imports were the only options to ease or constrict external trade. Kenya regularly used the options depending on the authorities’ objectives to counteract negative developments on the balance of payments. Figure 1 below shows the trade neutralizing import tax charges in Kenya. Tariff structure 1995/1996 1996/1997 1997/1998 1998/1999 0 0 0 0 5 5 5 5 10 15 15 15 15 25 25 25 25 35 40 16.1 14.1 12.3 n.a Weighted average tariff S.D S.D S.D S.D Pref. offsetting measures 14.5 15.3 13.8 n.a Kenya increasingly employs ‘suspended duties’ which mostly involve an additional tariff of 5-20% on a wide range of goods (Heller, 1988). By imposing a tariff the U.S. may be able to turn the terms of trade in its favor. This increase may be big enough to overshadow the loss from a condensed volume of trade. The tariff causes the price of domestic purchases to rise but the price received by foreign suppliers, falls. A segment of the tariff revenue raised is not just a transfer from domestic purchasers, but comes from foreign producers. However, when imports declines, economic competence declines which symbolize the joint effect of less efficient domestic producers increasing their output and of domestic consumers shifting to less attractive substitutes. In spite of whether a country levies an import tariff or export tax, its gain comes at the cost of the rest of the world. In fact, because the tariff reduces the extent of specialization in the world economy, world welfare is reduced. The terms-of-trade argument takes a national standpoint: it suggests that a nation may be in a position to use a tariff to take for itself a better share of the gains from trade, thus improving its welfare. This argument is rationally correct, but is it extraneous for most nations of the world that put forth little pressure on world prices, such as Kenya. Even for large countries (such as the U.S.), the benefit obtained through enhanced terms of trade may be lost if other countries strike back by imposing tariffs of their own. However, the damage may not be as significant as if a small country was involved. Any benefits may also wear away if the higher relative prices of the U.S’s export attract better entry and competition from producers in other countries (OECD 2010). The optimum tariff will decline over time. Kenya is a small nation and does not affect the world prices by its trading. Thus, the imposition of an import tariff or tax reduces the volume of trade by an amount too small to affect world prices. With higher domestic prices for the importable commodity, domestic producers enlarge the production of the importable commodity until its price rises to the level of the world price plus the tariff. Domestic consumers will buy less of the importable commodity at the higher tariff-inclusive price that they have to pay. With domestic production of the importable commodity increasing and domestic consumption declining, the import of the commodity by Kenya falls. Since domestic consumers pay a price for the importable commodity which is higher than the world price by the amount of the import tariff but the tariff is collected by the government of the nation, the price of the importable commodity remains unaffected at the world price level for the nation as a whole. It is implied that the government then uses the tariff revenue to reduce taxes or offer additional services. With less specialization in production and a small volume of trade at unaffected commodity prices for the nation as a whole, the nation’s interests declines (Lazear 2000). In conclusion, the effect of an import tax or tariff is to reduce the amount of quantity imported at the same time increasing the quantity produced locally. When a country imposes a tariff on its imports, the price of import rises meaning that consumers have to part with a large sum of money if there are to purchase the imported product. Since the price of imports becomes higher compared to that of locally produced products, consumers may choose to purchase locally produced products. This results in an increase in domestic production which boosts a country’s terms of trade. On the other hand, the exporting country incurs a reduction in the quantity exported as the importing country substitute the imported commodity with local products. However, the effects of an import tariff vary from one country to the other. A developed economy such as the U.S. gains more from an import tariff than a small economy such as Kenya since it has a greater influence on international prices. For internationally traded commodities in which a country is a price taker in the world market, scarcity value or opportunity cost is represented by the border price of these commodities. This is the world market price at the country’s border. While a liberally operating market would create that price arrangement, government involvements are essential to search out the right prices in instances when the market is not functioning properly. When a country is a large exporter or importer of a commodity in the world market so that the world price is affected by its level of exports or imports, there is also a case for intervention through an optimal export or import tax Reference List Carbaugh, R. J. (2008). International Economics. London: Cengage learning Dinopoulos, E. (2008). Trade, Globalization and Poverty. London: Routledge Ebrill, L. P. et al (1999). Revenue Implications Of Trade Liberalization. Volume 180 Of Occasional Paper. Washington D.C: International Monetary Fund. Heller, P. S. (1988). The Implications Of Fund-Supported Adjustments Programs For Poverty: Experiences In Selected Countries. Washington D.C: International Monetary Fund Krugman, P., & Robin, W. (2006). Economics. New York, Worth Publishers Lazear, E.P. (2000). "Economic Imperialism," Quarterly Journal Economics, 115(1)|, pp. 99–146. Organization for Economic Co-operation and Development (OECD) (2010). OECD Trade Policy Studies The Economic Impact Of Export Restrictions On Raw Materials. OECD Publishing Salvatore, D. (2005). Introduction to International Economics (First ed.), Hoboken, NJ: Wiley . Sexton, R. L. (2010). Exploring Economics. London: Cengage Learning. Tokarick, S. (2006). Does import protection discourage exports? Issues 2006-2010.Washington D.C: International Monetary Fund Read More