Tariff Pass-Through to Domestic Prices

Tariff pass-through is the extent to which a tax on imports raises prices paid within the importing country. An import tariff increases the cost of bringing a product into the country, but the resulting consumer-price increase depends on how that cost is shared among foreign suppliers, importers, retailers and buyers.

How a tariff reaches consumer prices

The importer pays the tariff to the importing country's government. This legal responsibility does not establish who ultimately bears the economic burden: businesses can pass some or all of the additional cost to buyers.

• An ad valorem tariff is calculated as a percentage of the imported product's customs value.
• For example, a 10% tariff on an import valued at ₹100 adds ₹10 to its import cost, assuming the foreign price and exchange rate remain unchanged.
• If importers and retailers preserve their absolute margins and other costs remain unchanged, full pass-through raises the final selling price by ₹10 in this example.
• The percentage increase in the retail price need not equal the tariff rate because the retail price also includes domestic distribution costs and margins.

What determines the extent of pass-through?

Economic incidence, meaning who ultimately bears the burden, depends on market responses rather than simply on who pays the tax.

• Foreign suppliers may reduce their pre-tariff prices to retain customers, absorbing part of the tariff and limiting the importing country's price increase.
• Importers and retailers may accept lower profit margins, rather than pass the entire additional cost to consumers.
• The availability of substitutes and the responsiveness of supply and demand affect how easily sellers can raise prices without losing sales.
• Exchange-rate movements can reinforce or offset the tariff's effect on import costs; an appreciation of the importing country's currency can provide an offset.
• Pass-through can change over time as contracts are renewed and firms or consumers switch suppliers.

Why prices can rise beyond imported goods

Tariffs can affect both imported products and goods produced within the importing country.

• Tariffs on intermediate inputs, such as components or raw materials, can raise domestic producers' costs and therefore the prices of their finished products.
• Tariffs can reduce import competition, allowing competing domestic producers to charge higher prices.
• Consumers may switch to domestic substitutes, increasing demand for them and putting upward pressure on their prices when supply cannot expand readily.