• President-elect Donald Trump has threatened to slap tariffs on goods from Mexico, Canada, and China.
• Tariffs raise money but may also affect prices and employment, and they can lead to trade wars.
• Here's a guide to tariffs, including who pays them, how they work, and how they affect the economy.

Tariffs are back in the spotlight after President-elect Donald Trump pledged to impose 25% tariffs on goods from Mexico and Canada and an additional 10% duty on goods from China, unless those countries stop the flow of illegal immigration and narcotics into the US.

Trump's tariff threat could be a negotiating ploy to win better terms with America's three biggest trading partners. But if the tariffs are imposed, they could affect prices, employment, and the broader US economy — especially given the risk that China, Canada, and Mexico may retaliate with tariffs, triggering a trade war.

Here's what you should know about tariffs and why they matter.

What are tariffs?

A tariff is effectively a government tax specifically levied on foreign goods imported into a country.

Tariffs date back more than 200 years and were historically used by authorities to raise money. The US government collected most of its revenue from tariffs before introducing an income tax in the early 1900s.

Authorities now use tariffs primarily to protect domestic industries from foreign competition and punish trading partners for bad behavior.

There are four types of tariffs:

• An ad valorem tariff is calculated based on the value of the good. If an imported product is worth $10 and the tariff is 10%, the importer has to pay $1.
• A specific tariff is imposed on a per-unit basis, so the value of the item doesn't matter. An importer might have to pay $1 for every pound of cocoa beans it brings into the country, whether it brings in 10 bags or 1,000.
• A compound tariff combines elements of ad valorem and specific tariffs. The tariff on an imported item could be $1 per pound or 5% of its value, depending on which generates more revenue.
• A mixed tariff applies both an ad valorem and a specific tariff, meaning an importer might have to pay $5 a pound and 10% of its value as well.

Who pays tariffs? How do they work?

The news that Trump threatened Canada with tariffs, along with Mexico and China, has made it important to understand who pays tariffs and how they work.

In the US, the simple answer is that the person or business importing the tariffed product into the US pays the tariff, and the money is paid to the US Treasury.

For example, if General Motors imports parts from its factories in Mexico and assembles its cars in the US, it would have to pay tariffs to bring in those parts.

Customs and Border Protection agents collect tariffs at 328 ports of entry, including docks, airports, and border crossings.

How do tariffs affect prices and the economy?

Tariffs raise costs for importers, and to protect their profit margins, importers typically pass on those costs by charging higher prices to their domestic customers — whether they're companies or consumers.

Those price hikes can benefit domestic producers because the hikes make their goods relatively cheaper to bring to market than imported alternatives. For example, they might make it easier for US apparel manufacturers to compete with Chinese fast-fashion companies such as Shein and Temu.

Tariffs can also spur foreign producers to drop their prices to try to keep their products competitive, hurting their domestic industry and their country's economy, and partly offsetting the upward pressure on prices from tariffs.

The countries involved may also trade lower volumes of the product if both supply and demand fall in response to the tariffs.

A 2019 research paper on the initial impact of Trump's first-term tariffs found they fully passed through into the domestic prices of imported goods — and hurt consumer choice by reducing the availability of imported varieties.

Tariffs are frequently pitched as a tool to protect domestic jobs. A National Bureau of Economic Research working paper published in January found that the 2018-2019 trade war did not affect employment in newly protected sectors. The study also found that retaliatory tariffs from other countries contributed to job losses in domestic sectors such as agriculture and were only partly mitigated by federal subsidies.

Advantages of tariffs can include stronger domestic industries, increased government revenue, and pressure on other countries to stop unfair trading practices and help address issues such as illegal immigration and the drug trade.

Disadvantages can include tariffs' effects on consumers in terms of higher prices and reduced choice, plus the risk of retaliatory tariffs that could lead to employment losses in some industries and a full-blown trade war.

Moreover, a study published in The Economic Journal in 2021 found that retaliatory tariffs "disproportionately targeted more Republican areas," suggesting they were aimed at Trump's base to try to maximize their political power.

How Trump's tariff plan would work

Trump is no stranger to using tariffs. He called himself "Tariff Man" during his first term for imposing tariffs on products such as steel and aluminum plus a wide range of Chinese goods.

He replaced the North American Free Trade Agreement with the United States-Mexico-Canada Agreement in his first term, allowing most goods to continue freely passing between those countries.

That would change if Trump goes ahead with sweeping tariffs on Mexican and Canadian goods. Products passing into the US from its northern and southern borders would be subject to duties, and the money collected would flow to the US Treasury.

A key question is whether the tariffs would result in higher inflation. Inflation, or the annualized pace of price increases, hit a 40-year high of more than 9% in 2022, spurring the Federal Reserve to raise interest rates from nearly zero to above 5% in less than 18 months.

Inflation has dropped below 3% in recent months, freeing the Fed to begin cutting rates. The question is whether Trump's tariffs would cause price growth to accelerate again and delay further rate cuts — especially as people's deep concerns about higher living costs was a key reason they reelected him.

• President-elect Donald Trump on Monday threatened to impose 25% tariffs on goods from Canada.
• In making his statement on Truth Social, Trump criticized Canada over immigration policy and drugs.
• Roughly 77% of Canada's exports go directly to the US, per the Toronto Region Board of Trade.

President-elect Donald Trump has made waves this week with his vow to impose new tariffs on imported goods from Canada, China, and Mexico, which also happen to be the United States' top trading partners.

Trump's hard-line stance against China — a country that conservatives consider to be a threat to the US's economic and national security interests — is not a surprise. Neither are his threats regarding Mexico, whose border with the US has created contentious and high-profile immigration concerns.

But where does Canada, the US's northern neighbor, fit into the equation alongside China and Mexico?

In short, Trump says he has the same concerns over immigration, fentanyl, and crime from the Canadian border as he does Mexico's.

While it's possible the tariff threats are part of Trump's negotiation strategy, there has been a sharp increase in apprehensions at the US-Canada border over the past year. From October 2023 through September 2024, US Border Patrol made 23,721 arrests at the US-Canada border, compared with the 10,021 arrests that were made in the preceding 12-month period, according to Customs and Border Patrol data. The New York Times and NPR reported that Indian nationals in Canada on temporary visas made up a large portion of the surge of illegal border crossings into the US.

Few things animate Trump more than immigration, one of his defining issues and one that he's zeroed in on since his first presidential run in 2016. The president-elect's firm stance on border security has earned him enduring loyalty from the party's base.

Justin Trudeau, Canada's prime minister, immediately addressed the concerns within his country, telling reporters on Tuesday that he had a "good" conversation with Trump following the president-elect's pledge to target his country.

"We talked about how the intense and effective connections between our two countries flow back and forth," Trudeau said. "We talked about some of the challenges that we can work on together."

Trump on Monday criticized both Canada and Mexico over the issue on his Truth Social platform.

"On January 20th, as one of my many first Executive Orders, I will sign all necessary documents to charge Mexico and Canada a 25% Tariff on ALL products coming into the United States, and its ridiculous Open Borders," Trump wrote on Truth Social. "This Tariff will remain in effect until such time as Drugs, in particular Fentanyl, and all Illegal Aliens stop this Invasion of our Country!"

If enacted, the ramifications of such tariffs could be enormous, as about 77% of Canada's exports go directly to the US, according to the Toronto Region Board of Trade.

And some trade experts have warned that if Trump actually imposes the tariffs, he'd be violating the US-Mexico-Canada Agreement, which was brokered during his first term in office to replace the North American Free Trade Agreement — the 1990s-era free-trade pact Trump had long railed against.

Jake Colvin, the president of the National Foreign Trade Council, said Trump's proposed tariffs would trigger a "clear violation of the USMCA," according to Roll Call.

"While we're all familiar with the President-elect's fondness for tariffs as a negotiating tool, it's particularly troubling that he's threatening to aim them at America's closest allies and trading partners on the very first day of his administration," he said.

Chrystia Freeland, the deputy prime minister of Canada, and Dominic LeBlanc, the country's public-safety minister, responded to Trump's remarks in a joint statement on Monday, touting the mutually beneficial alliance between the two countries.

"Canada and the United States have one of the strongest and closest relationships — particularly when it comes to trade and border security," the top officials wrote on X. "Canada places the highest priority on border security and the integrity of our shared border."

"In addition, the CBSA [Canada Border Services Agency] is continually strengthening its ability to detect opioids through enhanced inspections at ports of entry, detector dogs, and emerging technologies, preventing opioids from entering and leaving Canada," they added.

The officials then pledged to work with Trump's second-term administration in tackling the issues he raised.

Business Insider reached out to a representative of Trump for comment.

• Donald Trump's latest tariff threats have set alarm bells ringing on Wall Street.
• The president-elect said he would impose tariffs on exports from Mexico and Canada, as well as China.
• Analysts warned of a trade war, volatility, steeper inflation, and a flight to safety in markets.

Donald Trump rattled financial markets late Monday by warning he would slap 25% tariffs on Mexican and Canadian exports to the US until the flow of illicit drugs and illegal migrants into America stops. He also said he'd impose another 10% tariff on imports from China until the drug problem is resolved, in addition to the 60% he proposed during the election campaign.

Analysts said the president-elect's latest threats could presage tariffs on other countries' exports and escalate into a full-scale trade war. They also said it could fuel volatile trading and a flight to haven assets in markets. There's also the threat of stoking inflation, meaning interest rates stay higher for longer.

Here's what analysts and commentators are saying:

George Saravelos, global cohead of FX research at Deutsche Bank

"Free trade agreements are not safe. Canada and Mexico are part of the USMCA which was negotiated by Trump himself. It is clear that even countries with existing agreements with the US can be subject to tariffs.

"The softer the market reaction, the greater the likelihood of more tariffs. The equity market reaction has so far been very benign, we would argue likely on the back of the transactional interpretation. That US domestic small-caps have been leading the recent market rally also helps reduce the impact. The first Trump administration showed that the more benign the market reaction, the greater the likelihood of further escalation."

Dan Coatsworth, investment analyst at AJ Bell

"If those tariffs are at the top of his agenda, there is now an elevated risk they will be closely followed by punishing tariffs on other countries. Trump clearly wants to make his mark and show he's the boss.

"There has been a view among some investors that Trump's tariff talk was a negotiating tactic, a threat rather than a promise. That might still end up the case, but it's clear that the president-elect has no intention of backing down for now."

Matt Britzman, senior equity analyst at Hargreaves Lansdown

"European equity markets braced for a sharp drop on Tuesday as Trump's tariff threats against China, Mexico, and Canada sent shockwaves through global sentiment.

"The president-elect's scorched-earth approach has stoked fears of a trade war, with investors increasingly wary that Europe could be next in his crosshairs."

Nigel Green, CEO of deVere Group

"These tariffs will not only drive up costs for companies but also fuel inflation, which could lead to further tightening of monetary policy.

"Markets hate uncertainty, and the prospect of a full-blown trade war will send investors scrambling to reassess their exposure."

Mark Haefele, chief investment officer of UBS Global Wealth Management

"While investors are once again on edge following Trump's latest tariff threats, we think markets also recognize that the risks of higher inflation and interest rates are implicit constraints on his policy agenda, with eventual policy outcomes potentially less inflationary than some investors previously feared.

"We see further volatility ahead, but we also expect US Treasury yields to fall in the year ahead following a 65-basis-point rise over the past two months."

Ruben Ferreira, FlowCommunity

"The medium to long-term outlook could shift if trade tensions escalate, potentially disrupting international trade relations.

"Such developments may heighten market uncertainty, driving increased demand for safe-haven assets such as gold as investors seek protection against market risks and economic instability."