Prior to his inauguration, United States President Donald Trump threatened to hit Canadian exports with tariffs of up to 25 per cent. In response, Canadian officials have vowed they could retaliate with tariffs of their own on a raft of U.S. goods and services. Here, the Financial Post’s Serah Louis explains how tariffs work, and why consumers are the ones who end up losing out.

How do tariffs work? 

“A tariff is essentially a tax that you put on goods and services that you import from another country,” said Fen Osler Hampson, professor of international affairs at Carleton University and co-chair of the Expert Group on Canada-U.S. Relations. 

Tariffs are paid by the importer, not the exporter. For instance, if the U.S. puts a tariff on Canadian goods, the American company or individual that imports our goods must pay the fee to the U.S. government. So for the importer, a 25 per cent tariff has an effect similar to a 25 per cent price increase. Because it must now pay more overall to buy the Canadian goods, the company might try to negotiate a cheaper price or it might be forced to look for alternatives outside of Canada instead. In either case, it will usually be paying more than before, and that cost will ultimately be passed along to consumers.

Traditionally, tariffs have been used to protect a country’s industries at risk of going out of business or having trouble competing with producers from other countries, Hampson said. Tariffs can also be used to gain leverage during Canada-U.S. Relations., or as a way to generate revenue for governments, though that revenue comes at a cost.

“It’s obviously inefficient in an economic sense, because it’s raising the price of goods and services, as any tax will do,” Hampson said, comparing tariffs to a goods and services tax (GST) at the border. 

Who really pays for tariffs?

Although Trump has said the foreign country is the one that ultimately pays for tariffs that the United States imposes on its goods, the reality is it would be American importers, with collateral damage for businesses and consumers.

Michael McAdoo, partner and director at Boston Consulting Group (BCG) Montreal, offered the example of a Canadian auto part, like a $1,000 dashboard, that might get exported to the U.S. In the case of 25 per cent tariffs, its importing company (say, General Motors) would have to pay $250 in order to take that product into the United States, on top of whatever costs it typically pays to the supplier.  

These costs can also compound onto the consumer, said Andreas Schotter, a professor of international business at Western University’s Ivey Business School. 

The more costly auto part gets added onto the price of the car, which means if the car is shipped back to Canada, the Canadian consumer also pays more to purchase the vehicle. If there’s a GST or harmonized sales tax (HST), the higher base price for the car means the consumer shells out more on taxes as well.   

“Tariffs are never good for the consumer,” Schotter said.  

He added that tariffs can reduce demand for these imported products, which means businesses may cut back on production and as a result labour, leading to job losses and currency devaluation.  

Walid Hejazi, a professor of economic analysis and policy at the University of Toronto’s Rotman School of Management, noted that in some cases, the exporting company might choose to lower the price of its goods to avoid losing customers in the foreign market. However, this also depends on how long the company can survive on lower profits. 

If the exporters do not lower the price of their goods, then the importers can either absorb these costs and accept lower profits or pass the higher costs on to their domestic consumers.  

How might a trade war hurt Canadian consumers? 

There are several ways a trade war could hit Canadians. There is the risk that as prices on Canadian goods exported goods go up for Americans, they may buy less of these goods, which could impact Canadian businesses and jobs.

But certain products are part of a complex supply chain, meaning products using those Canadian goods could return to Canada as a more expensive product for Canadian consumers. 

The stakes are high for big companies in Canada’s energy sector and for the auto industry, Hampson said.  

Vehicles are the second largest Canadian export by value at $51 billion, of which 93 per cent was exported to the U.S. as of 2023, according to the Canadian Vehicle Manufacturers Association. Some auto parts and components can cross Canadian-U.S.-Mexican borders up to eight times before they are installed in a final assembly.  

That said, Hampson added the scale of this impact is dependent on elasticity of demand — meaning, can Americans buy these goods or services at a lower or more competitive price elsewhere? 

In the case of energy, Hampson said it’s unclear where the United States might procure heavy oil, if they are not purchasing crude from Alberta at a reduced price. 

“It goes to the refineries in Louisiana and Texas; they can’t just flip a switch and suddenly start processing lighter crude,” he said. “In that sense, demand is fairly inelastic; they’re still going to have to buy it, probably at roughly the same volumes, at a higher price.” 

How might Canada retaliate?

The other side of a potential trade war comes down to retaliatory tariffs that Canada could impose upon U.S. goods. In fact, the Canadian federal government is reportedly preparing for an initial round of retaliatory tariffs on about $37 billion of goods, which could potentially be expanded later, if Trump makes good on his threats. 

Canada is likely to target these tariffs to industries and products that would hurt the United States the most and cause the least harm to Canadian consumers, experts have said. On the list of potential goods Canada might target are American steel, ceramics and plastics, or steel, ceramics and plastics.

For example, during the first Trump administration, when the U.S. put tariffs on steel and aluminum, Canada responded with its own tariffs on steel and aluminum, as well as in other product categories. 

McAdoo brought up tariffs on U.S. cranberries as an example, mainly grown in then-House Speaker Paul Ryan’s home state of Wisconsin. Since Canada grows its own cranberries as well, this tariff did not have as large an impact on Canadian consumers.  

“By targeting those Wisconsin berries, you had a bunch of people in a 2016 Trump state with a very vocal Trump acolyte (that were hit hard) because Canada was taking so much of their production,” McAdoo said. “These types of micro targeted tariffs can have really precise impacts.” 

However, if Canada expands its list of counter-tariffs, the harm to its consumers could be exacerbated. 

“Everything that gets put on the table is likely to go up,” said Hampson, highlighting how low- to middle-income consumers are likely to be hit the hardest, since the costs of these goods and services make up a larger part of their budget and tariffs are inflationary.  

Hampson pointed to machinery, mineral fuels, electronic equipment, steel, paper, pharmaceutical products, organic chemicals, aluminum, furniture and edibles as goods that could potentially face tariffs. Even produce that gets shipped from Mexico could be affected if it goes through the United States.  

A potential tariff war between Canada and the United States would likely take longer to resolve than it did last time, Schotter said. 

“I think this time around Trump’s attitude is different,” he said. “I think he is much more erratic, much more unpredictable, and much more forceful, and not necessarily listening to the governors of these states.”  

What could Canada do to offset the impact on consumers? 

To offset the damage to consumers hit by inflated prices, one option could be to use a fund collecting tariffs toward compensation, experts theorized. If Canada did slap tariffs on U.S. goods, some of the tariff revenue could potentially go toward a compensation program, perhaps in the form of subsidies.  

However, this would be more of a Band-Aid solution than anything else, Schotter said, and is unlikely to be sustained in the long term.   

Hampson said the Canadian economy is built on small and medium enterprises, with many of them being providers to bigger companies.  

“Because of the integrated nature of distributed supply chain, they’re the ones who are going to really take a hit,” he said. “If you’re a big oil company in Alberta, you’re probably going to be able to absorb the shock.” 

The Canadian Federation of Independent Business recently said a tariff war would lead two-thirds (65 per cent) of small businesses to increase prices for consumers to offset the impact.

The Canadian government might consider handing out subsidies to smaller businesses as they did during the COVID-19 pandemic, Hampson suggested, but he is unsure if it can afford to do so.  

“These are major tariffs. I mean, it’s going to be quite devastating.”