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How Do Tariffs Work? Who Pays, Who Collects and More

Global X research analyst Brooke Thackery shares his analysis on the tentative tariff agreement between the U.S. and Canada.

(Bloomberg) --

US President Donald Trump has rattled economies and markets with his promise of imposing punitive tariffs on the nation’s largest trade partners. So far he’s implemented 10% levies on China; delayed plans to hit Mexico and Canada with a 25% duty tax; and indicated that he’s coming for the European Union next. Yet beyond all that noise, tariffs have on-the-ground implications. Here’s how they work — from who actually pays to how the revenue is collected.

What are tariffs and what purpose do they serve?

Tariffs are taxes imposed on imported goods. Like all taxes, they are a source of government revenue. Countries have long relied on them to support local industries by making foreign products more expensive. Trump is using them as leverage to achieve foreign policy goals, too. That was the case with the planned levies on Mexico and Canada imports: Trump agreed to postpone them until March 1 after the two US neighbors agreed to take tougher measures to combat migration and drug trafficking at the border.

How are tariffs collected and enforced?

The US Treasury secretary is responsible for establishing regulations on the collection of tariffs, but US Customs and Border Protection, or CBP, is the government body tasked with enforcing them at nearly 330 ports of entry across the country — which include border crossings by roads or rail, as well seaports and airports. Agents review paperwork, perform audits and collect levies and penalties. The money is collected at the time of customs clearance and deposited into the Treasury Department’s General Fund. Those who fail to correctly describe the quantity, category or origin of a certain product — either on purpose or because of negligence — face penalties.

Some goods and components cross borders multiple times before becoming a finished product — such as a car with US-made parts assembled in Mexico and re-imported to the US. Under CBP rules, US-made products that are re-imported into the country without being “improved” or “advanced” in value are duty-free. Another example: Say the US exports gold to India, where it’s used to make earrings. The final product will be subject to tariffs when re-entering the US. In that case, even the value of the gold would be taxed.

How much money is generated by tariffs?

While tariffs used to be the US government’s main source of revenue, over much of the past century they have comprised a tiny share of government revenue. As of last year, they accounted for less than 3% of the federal revenue, according to a Federal Reserve Bank of St. Louis analysis of government data.

If permanently imposed as originally proposed, the combined tariffs on Canada, Mexico and China could translate into $1.1 trillion in additional costs for US importers in the next decade, according to estimates by the nonpartisan think tank Tax Foundation. In 2025 alone, the group projects the policy could raise levies by nearly $110 billion.

The Tax Foundation estimates that tariffs imposed on China by Trump during his first term and expanded during Joe Biden’s presidency currently generate $77 billion in annual revenue.

Who pays for tariffs?

Research has generally found that US consumers and businesses are the ones absorbing the costs from higher levies. Foreign producers may reduce their selling costs or US importers may absorb some of the costs. To avoid weaker profits, companies often choose to hike prices and pass some of that cost on to consumers instead. 

There are potential loopholes, however, such as an exemption process that allows companies to request relief from the tariffs if paying them would unduly hurt their business and there were no other options to buy products from another country.

What are the consequences of imposing tariffs?

The recent history of US trade with China helps explain what happens when tariffs are in place. During his first term, Trump imposed an array of tariffs on Chinese products including steel, aluminum and engines. The Asian country went from supplying one in five goods the US imported before Trump’s first trade war in 2018 to about only 14% of US imports in 2023.

On top of that, when levies hit, importers often resort to tariff evasion. That can be done by shipping merchandise through a third country, underreporting the value of products or mislabeling them as similar goods that have lower duty rates. Goldman Sachs economists recently found tariff evasion can explain as much as $90 billion of the estimated $240 billion pullback in US imports from China compared with pre-trade war levels.

What is the “External Revenue Service” proposed by Trump?

The Trump administration has proposed the creation of a separate External Revenue Service to collect levies as part of his “America First” trade policy. Analysts have noted that tariff revenues aren’t an “external” source given that the levies are paid by US-based importers, which pass at least some of the cost onto US consumers. Still, the concept underscores Trump’s desire to frame tariffs on foreign imports as a source of revenue that isn’t shouldered by taxpayers. 

What does this all mean for trade treaties?

The US has free-trade agreements with 20 trading partners around the world — including Mexico and Canada, an arrangement known as the USMCA, or the new NAFTA. In these agreements, countries commit to bringing tariffs rates down toward zero. Trump’s now-delayed tariffs on Mexico and Canada would run contrary to the trade agreement between the three nations (due for re-negotiation in 2026). Trump also threatened Colombia with tariffs in his first week in office before an agreement was reached at the last minute.

As a member of the World Trade Organization, the US is bound to rules including limitations on the use of subsidies as well as trade barriers such as tariffs and quotas. In response to Trump’s latest round of tariffs on China, the Commerce Ministry in Beijing pledged to file a “lawsuit” against the US at the WTO, condemning the blanket tariff as a “serious violation” of international trade rules.

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