Tariffs: forms, structure and effects

Detail

1. Meaning of a tariff

• A tariff is a tax on goods that cross a country's border. It is mostly charged on imports, where it is called customs duty.
• It does two jobs:
• Revenue: the government earns money from it.

• Protection: imports become costlier, so domestic producers face less competition.

• A tariff is a price-based barrier. A quota is a quantity-based barrier, meaning a direct limit on how much can be imported. NCERT treats both as "trade barriers".

2. Effects of a tariff — the Chinese toys chain (Class 10)

• A tax is put on imported Chinese toys
• Importers pay the tax and pass it on, so buyers in India pay a higher price.
• Chinese toys lose their price advantage, so imports fall "automatically".

• Demand shifts to local toys, so "Indian toy-makers will prosper".

• Who gains and who loses

• Domestic producers gain because they sell more at higher prices.
• The government gains customs revenue.
• Consumers lose because they pay more and get less choice.
• Industries that use the imported good as an input lose because their costs rise.

3. Tariffs and purchasing power parity (Class 12)

• Purchasing power parity (PPP) means the same good should cost the same everywhere once prices are converted at the exchange rate.
• NCERT says PPP holds only "as long as there are no barriers to trade like tariffs (taxes on trade) and quotas".
• Worked example
• A shirt costs $10 abroad. At ₹85 per $, it should cost ₹850 in India.
• With a 20% tariff, its landed price becomes ₹850 + ₹170 = ₹1,020.

• This leaves a ₹170 gap that lasts. Traders cannot remove it by buying abroad and selling at home, because the tariff eats their profit.

• So tariffs are one reason PPP fails in the real world.

4. Forms of tariff

Form	Basis	Example
Ad valorem tariff	A fixed % of the value of the import	20% on a ₹1,000 good = ₹200
Specific tariff	A fixed amount per physical unit	₹50 per kg
Compound tariff	Ad valorem + specific on the same good	10% + ₹20 per kg
Mixed tariff	Ad valorem or specific, whichever gives the higher (or lower) duty	10% or ₹30/kg, whichever is higher

• Specific vs ad valorem when world prices fall — worked example
• A good's world price falls from ₹100/kg to ₹50/kg.
• A 20% ad valorem duty falls from ₹20 to ₹10. Protection is halved.
• A ₹20/kg specific duty stays at ₹20, so its ad valorem equivalent rises from 20% to 40%.

• So specific duties protect more when world prices fall. They are also easier to administer, because customs officers only weigh or count the goods and do not need to check invoice values.

• Ad valorem duties keep pace with inflation. As prices rise, the duty in rupees rises with them. They are also more transparent, which is why WTO schedules mostly use them.

• Ad valorem equivalent (AVE) means a specific or mixed duty converted into a % of value so that it can be compared with other duties.
• India's practice
• In 2020/21, 93.9% of India's tariff lines had ad valorem rates.
• 725 lines (6.1%) had non-ad valorem rates. Of these, only 4 were specific and 721 were mixed, meaning ad valorem and/or specific.
• Mixed duties apply mainly to textiles and clothing (714 lines) and natural rubber products (7 lines) [3].

5. Export duties

• An export duty is a tax on goods leaving the country.
• Most export duties were removed after the 1991 reforms (Class 11). Today they are used selectively to:
• keep goods at home to control domestic prices (food security);

• support domestic processing (value addition) by making raw-material exports costlier.

• Examples

• Rice: 20% export duty on parboiled rice (2023), later removed.
• Onions: 40% (2023–24), removed from April 2025.

• Iron ore: duty rates vary with ore grade.

• The WTO Trade Policy Review notes that India uses export taxes, minimum import prices and licensing to manage domestic demand and supply. It also notes that frequent changes to these tools "create uncertainty for traders" [3].

6. Duty drawback and remission

• Duty drawback refunds customs and other duties paid on imported inputs that are used in exported goods.
• The logic is "export goods, not taxes": exports are zero-rated, meaning no domestic tax is left inside the export price.
• Remission schemes follow the same logic:
• RoDTEP refunds hidden central, state and local taxes built into export costs.
• Advance Authorisation allows inputs to be imported duty-free for export production.

7. Tariff structure

(a) Tariff escalation

• Tariff escalation means tariffs are low on raw materials, higher on semi-processed goods, and highest on finished goods.

• Example: raw cocoa 0% → cocoa paste 10% → chocolate 30%.

• The WTO says this practice "protects domestic processing industries and discourages the development of processing activity in the countries where raw materials originate" [6].

• Effect on poor countries: they are kept locked into exporting unprocessed commodities, with low value addition and few jobs.

(b) Tariff peaks

• A tariff peak is a relatively high tariff on a sensitive product, such as farm goods, textiles or footwear, when tariffs are generally low.
• For industrialised countries, tariffs of 15% and above are generally treated as tariff peaks [5].

(c) Effective rate of protection (ERP)

• The nominal tariff is the duty printed on the final good.
• The ERP is the % by which the whole tariff structure raises an industry's domestic value added above its free-trade value added. Value added is the output price minus the cost of inputs.
• Formulas
• ERP = (V′ − V) / V
  • V = value added at free-trade prices
  • V′ = value added at tariff-inclusive prices

• ERP = (t − a·tᵢ) / (1 − a)

  • t = tariff on output
  • tᵢ = tariff on inputs
  • a = input share in output value, at free-trade prices

• Worked example 1 (NCERT scaffold)

• A car sells for 100 at world prices and uses inputs worth 60, so V = 40.
• A 20% output tariff with 0% input tariff gives V′ = 120 − 60 = 60.

• ERP = (60 − 40)/40 = 50%. This is well above the 20% nominal rate.

• Worked example 2: input duty of 10%

• ERP = (0.20 − 0.6 × 0.10)/0.4 = 35%.

• So cutting input duties raises ERP: 0% input duty gives 50%, while 10% gives only 35%.

• Worked example 3: inverted duty structure

• Output tariff 10%, input tariff 40%.
• V′ = 110 − 84 = 26, so ERP = (26 − 40)/40 = −35%.
• Negative ERP means the tariff structure actually hurts the domestic producer. Its value added becomes smaller than it would be under free trade.

(d) Inverted duty structure

• An inverted duty structure exists when inputs face higher duties than the final product. It lowers ERP and can make it negative.
• It makes importing the finished product cheaper than making it in India. This has been a long-running complaint of Indian manufacturers.
• Policy correction in Budget 2025-26
• Basic customs duty (BCD) on Interactive Flat Panel Displays (the finished good) was raised to 20%.
• BCD on open cells (the input) was cut to 5%.

• The stated aim was to "rectify inverted duty structure and promote Make in India" [4].

• Rate simplification

• Budget 2025-26 proposed removing seven customs tariff rates for industrial goods.
• This was in addition to the seven removed in Budget 2023-24.
• It leaves only eight tariff rates, including zero [4].

• Only one cess or surcharge can now be levied on a good. Social Welfare Surcharge was exempted on 82 tariff lines that already carry a cess [4].

• Social Welfare Surcharge applies only to imports, at 10% [3].

8. India's applied tariff profile

• India's simple average applied MFN tariff rose from 13% (2014/15) to 14.3% (2020/21). It was 15.4% once AVEs are included [3].

• The main cause was a smaller share of low-rate lines. Lines at 0–10% fell from 79.1% (2015) to 67.8% (2020/21) [3].

• The most common rates were 10% (31.7% of lines) and 7.5% (24.4%). The highest rate was 150% on alcoholic beverages [3].

• Latest simple average MFN applied tariff (2025):
• 16.0% overall;
• 36.4% on agriculture;

• 12.8% on non-agricultural goods [2].

• The trade-weighted average (each tariff weighted by how much is actually imported) was lower, at 7.9% (2025) [2].

• This is because heavily imported items such as crude oil carry low duties.

• India's imports were US$ 720.0 billion (2024) [2].

9. WTO disciplines on tariffs

(a) Bound and applied rates

• The bound tariff rate is the maximum tariff a WTO member legally promises not to exceed on a product. It is listed in the member's schedule of concessions.

• To raise a tariff above the bound rate, a member must negotiate and compensate its trading partners.

• The applied tariff rate is the tariff actually charged at the border. It can be lower than the bound rate.

• Binding coverage is the share of tariff lines that have a bound rate.
• India's overall binding coverage is 74.3%, and 70.1% for non-agricultural goods [2].
• India has bound 100% of its agricultural lines, at rates from 10% to 300% [3].

(b) Binding overhang (India, WTO data for 2025)

	Simple average bound	MFN applied (2025)	Overhang
Total	50.8%	16.0%	~35 points
Agriculture	113.1%	36.4%	~77 points
Non-agriculture	36.0%	12.8%	~23 points

Source: [2] (NCERT scaffold: bound ~50% vs applied ~17%; agriculture bound ~113% vs applied ~39%)

• Binding overhang is the gap between the bound and applied rates. Within that gap, India can raise tariffs without breaking WTO rules.

• Example: India could raise the average farm tariff from 36.4% towards 113.1% with no WTO violation.

• The trade-off

• The gap gives India policy space, for example to protect farmers during a global price crash.
• Partners say it makes India's tariffs unpredictable.

(c) Tariffication and tariff-rate quotas

• Tariffication comes from the Uruguay Round Agreement on Agriculture. It means converting all non-tariff barriers on farm goods, such as quotas and bans, into tariffs [8].
• A tariff-rate quota (TRQ) is a two-tier tariff.
• Imports within a set quantity pay a low in-quota duty.
• Imports above that quantity pay a high out-of-quota duty [7].

• TRQs were created during tariffication so that some minimum market access continued.

• India's TRQs

• India has MFN TRQs on skimmed milk powder, some types of cream, maize and some edible oils [3].
• TRQs were also negotiated under preferential agreements with Nepal and Sri Lanka [3].
• The WTO notes that "in general, there are no imports under TRQs" [3].

• Only 0.9% of India's agricultural lines are under tariff quotas, and India uses no special safeguards (0%) [2].

• India's customs architecture (BCD, AIDC, SWS) is covered in the taxation note.

Prelims Hooks

• ERP = (t − a·tᵢ)/(1 − a). Cutting input duty raises ERP. An inverted duty structure can make ERP negative.
• Specific duty gives more protection when world prices fall. Ad valorem duty keeps pace with inflation.
• Compound duty = ad valorem plus specific. Mixed duty = ad valorem or specific, whichever is higher or lower.
• In the WTO glossary, a tariff peak is a tariff of 15% or above, a benchmark generally used for industrialised countries [5].
• Tariff escalation discourages value addition in the countries that export raw materials [6].
• Bound rate = the legal WTO ceiling. Applied rate = what is actually charged. Binding overhang = the gap between them.
• India, 2025: bound 50.8% vs applied 16.0%; agriculture 113.1% vs 36.4% [2].
• Tariffication and TRQs came from the Uruguay Round Agreement on Agriculture. India's TRQs cover skimmed milk powder, maize and some edible oils [3].
• Trap: Social Welfare Surcharge applies only to imports, but GST applies to both imports and domestic goods [3].
• Budget 2025-26 left only 8 customs tariff rates, including zero, for industrial goods [4].

Mains Points

• Policy space vs predictability
• India's large binding overhang (113.1% bound vs 36.4% applied in agriculture, 2025) [2] protects farmers and food security from swings in global prices.

• However, frequent rate changes "create uncertainty for traders" [3]. This weakens India's credibility in FTA talks and its attempt to join global value chains.

• ERP-based tariff reform for Make in India

• Low duties on inputs and moderate duties on outputs raise effective protection for assembly and manufacturing.
• Correcting inverted duties, as in the IFPD/open-cell change [4], and cutting the number of tariff rates [4] reduce disputes and support PLI-linked manufacturing.

• The risk: too much effective protection can make firms inefficient, as in the pre-1991 import-substitution era (Class 11).

• Tariff escalation as a development and equity issue

• Escalating tariffs in rich-country markets keep developing countries exporting raw commodities [6]. This supports India's Doha-round and G20 push for tariff cuts on processed goods.

• India's own export duties on raw materials, such as iron ore, are the mirror image. They try to push value addition inside India.

• Tariffs in an era of trade fragmentation

• With rising unilateral tariffs and sanctions, WTO bound rates act as a legal anchor.
• Duty drawback, RoDTEP and Advance Authorisation keep exports zero-rated, so that tariff protection at home does not become a tax on exporters.