How do tariffs work? Who pays, who collects and more

NEW YORK – US President Donald Trump has rattled economies and markets globally with his promise of imposing punitive tariffs on America’s largest trade partners.

So far, he has implemented 10 per cent levies on China, delayed plans to hit Mexico and Canada with 25 per cent levies, and indicated that he is coming for the European Union next.

Yet, beyond all that noise, tariffs have on-the-ground implications. Here is 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.

Mr 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: Mr Trump agreed to postpone them until March 1 after the two US neighbours 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 road or rail, as well as seaports and airports.

Agents review paperwork, perform audits and collect levies and penalties. The money is collected at the time of Customs clearance.

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 into 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 is 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 at 2024, they accounted for less than 3 per cent of the federal revenue.

If permanently imposed as originally proposed, the combined tariffs on Canada, Mexico and China could translate into US$1.1 trillion (S$1.5 trillion) in additional costs for US importers in the next decade, according to estimates by the non-partisan think-tank Tax Foundation. In 2025 alone, the group projects the policy could raise levies by nearly US$110 billion.

The Tax Foundation estimates that tariffs imposed on China by Mr Trump during his first term and expanded during Mr Joe Biden’s presidency currently generate US$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 US tariffs.

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, Mr Trump imposed an array of tariffs on Chinese products including steel, aluminium and engines.

China went from supplying one in five goods the US imported before Mr Trump’s first trade war in 2018 to about only 14 per cent 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, under-reporting the value of products or mislabelling them as similar goods that have lower duty rates. Goldman Sachs economists recently found tariff evasion can account for as much as US$90 billion of the estimated US$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 Mr Trump’s “America First” trade policy.

Analysts have noted that tariff revenues are not an “external” source given that the levies are paid by US-based importers, which pass at least some of the cost on to US consumers.

Still, the concept underscores Mr Trump’s desire to frame tariffs on foreign imports as a source of revenue that is not 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, with an arrangement known as the US-Mexico-Canada Agreement, or the new North American Free Trade Agreement. In these agreements, countries commit to bringing tariff rates down towards zero.

Mr Trump’s now-delayed tariffs on Mexico and Canada would run contrary to the trade agreement between the three nations (due for renegotiation in 2026).

Mr 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 Organisation (WTO), 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 Mr 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. BLOOMBERG