source : corporatefinanceinstitute

When it comes to international trade, there are certain taxes imposed on the import of goods that have to be paid for by domestic importers. A tariff is one such tax levied at trading borders and is a good source of revenue for the government. In the following article, you will learn about what tariffs mean, their purpose and their types.

A tariff, also known as customs duty, is a tax levied on a country's imported goods at the border. The terms 'tariffs', 'custom' and 'duty' can be used interchangeably. It is levied on the domestic importers of a country.

Tariffs mean a way of revenue generation for the government. Additionally, it also serves multiple other national interests, such as promoting domestic and local goods and services by making them more affordable.

It is seen as a protectionist barrier by the government to make the imported products less desirable or competitive in the market compared to the domestic & local alternative goods and services. Additionally, tariffs are also a big source of revenue for the government.

A tariff imposed on imported goods helps to support a developing economy. Here are some objectives of tariffs:

• Support domestic producers: Government intends to support local or domestic producers by imposing taxes on imported products. This, in turn, also benefits the employment sector of a country.
• Safeguard domestic consumers: Sometimes, it may be the case that certain imported products contain harmful substances for consumers. Hence, overly priced products will keep consumers away from purchasing imported goods and services.
• Support indigenous industries: In this growing economy of a developing country, it is important to support the newly emerging industries and companies. Tariffs imposed on imported goods will divert the consumers towards purchasing from local producers.
• Protect dependence on domestic industries of national importance : Government may need to protect the business which holds strategic importance to national security from being overly dependent on imported goods & services.

Tariffs work by increasing the prices of imported goods and reducing the competition for the domestic market or industries, especially emerging ones. Tariffs have the purpose of making comparatively cheaper domestic products more attractive to consumers at affordable rates.

It is controversial whether a free market policy would improve the economy more than trade barriers. Many economists agree that tariffs harm the market more than doing any good. They can make the domestic market less productive and innovative by reducing the competition, as the experts would say. Many such scenarios might reflect light on how tariffs are not always beneficial for both the producers and consumers.

There are four principal types of tariffs applicable – specific tariffs, compound tariffs, ad valorem (according to the value), and tariff-rate quota. Here is a brief description of these types:

• Specific tariffs: A specific tariff is levied on a product irrespective of its value. It depends on the number of units or weight of the imported product rather than its value. For example, a country can levy Rs. 15 on a pair of shoes but Rs. 100 on a single jacket.
• Compound tariffs: A compound tariff depends on the imported product's unit and value. For example, if the tariff imposed on imported apples is Rs. 5 per unit, a compound tariff will include this and an additional percentage on the value of the goods. 
• Ad valorem: "ad valorem" is a Latin word that means "according to value". Hence, it is quite understandable that this type of tariff is applicable based on the import value of the product. This is calculated in the form of a percentage rather than a monetary figure.  For example, Japan levies a 15% tariff on US automobiles.
• Tariff-rate quota: A tariff-rate quota combines two trade policies - tariffs and quotas. It levies a specific tariff rate on imported goods up to a specific amount. For example, a country can levy a 10% tariff on 5000 bags but when the number exceeds 5000, the tariff rate will be increased to 20%.

Now that you have gained some knowledge on what tariff means and its purpose, it will be easier to comprehend how imports and exports work for a country and why tariffs are levied on imported products.