Imagine buying a bed from Ikea and starting to assemble it. To do so, you grab a sledgehammer and start to pound dowels into bed frame boards. As you swing the sledgehammer, you knock out chunks of drywall. You do manage to drive in the dowels without ruining the bed, but you also have ruined drywall. Using a better tool would have avoided that collateral damage.
The Trump administration’s sweeping, stiff tariffs announced on April 2 would cover the vast majority of goods imported into the United States at rates not seen since at least the 1930s, and maybe not since the 1800s. The executive order justified the tariffs by saying they would boost U.S. manufacturing and reduce the U.S.’ bilateral trade deficits — with the administration also touting the tariffs’ revenue raising potential.
Unfortunately, many observers see President Donald Trump’s tariff package as more of a sledgehammer solution: While it may help reach some goals, it will cause needless extra harm. More appropriate tools would allow this administration to reach the same goals at lower cost.
Whom do tariffs help and harm?
Tariffs are taxes on imported goods. In the U.S., customs agents at some 360 ports enforce tariffs. They ensure that whoever imports the good — Walmart, Target, Home Depot, Lowe’s, Dole, Samsung, Toyota — pays the required fee to the United States Department of the Treasury.
The importers mentioned above cannot simply swallow the tax and keep prices the same. They raise their prices to cover the higher cost of getting those goods to consumers. Tariffs that Trump imposed in his first term and continued in the Biden administration raised prices for buyers by a percentage close to the tariff rate.
Thus, ultimately, all people who buy imports — business people importing parts for their firms and consumers purchasing final goods at the store — pay for the tariffs.
Does the price really have to rise? Can’t foreign suppliers drop out of the market and allow domestic producers to fill the gap while charging the same price?
If domestic producers could have filled the gap at the same price, they would have done so before the tariff, and we would not have had imports. The fact that the U.S. was importing those goods before the tariff reflects that fact that U.S. producers cannot satisfy market demand at the same price as foreign producers.
So, to restrict or ban imports will cause prices to rise, as U.S. producers produce at higher costs. Imposing a 54% tax on Chinese cellphones will not mean that the U.S. can magically step in and produce those same cellphones at the same Chinese cost. The price will rise to reflect higher U.S. costs.
One may say: Maybe foreign suppliers will lower their prices to preserve market share, thus shielding consumers from higher prices. For almost all imports, though, strong competition in those markets means that the pre-tariff price is quite close to that required to cover costs. Firms exporting to the U.S. have little ability to lower prices and still cover costs. Just like the importers, exporting firms cannot simply swallow the tariff by lowering their prices. They will have to reduce their sales, leading to higher prices.
This discussion of whom tariffs harm reveals who gains: U.S. producers of goods that compete with imported goods. With protective tariffs in place, domestic producers raise their prices and thus cover the increased costs connected with replacing lost output from foreigners. These domestic producers end up selling more goods at higher prices, a gain for them.
This gain, though, is mitigated, and could even be eliminated, by the fact that these domestic producers often rely on foreign inputs. Tariffs on all those inputs could actually cancel the gains U.S. producers would receive from restricted competition. This is why all three U.S. automaker stocks fell after the announcement, even though foreign cars would face a 25% tariff.
Someone else benefits: the government. It gets more revenue. Tariffs will never account, though, for more than 10% of the federal budget. So, we should not expect them to have a significant effect on the deficit or allow for significant tax cuts elsewhere.
With some gains and some losses, what is the net effect? Alas, tariffs’ costs to consumers outweigh the combined gains for domestic producers and the government. Those higher prices for imported goods reduce the total amount sold, and reducing the amount sold of goods reduces societal wealth.
This is because each sale of a good represents a free exchange that benefits both buyer and seller. Sellers benefit by getting a price that covers or exceeds their costs; otherwise, they would not sell at that price. Buyers benefit by getting a good whose economic value to them exceeds the price paid; otherwise, they would not buy it. Thus, wealth rises with each sale, which means that reducing the number of sales reduces wealth.
Since tariffs reduce the number of sales and thus wealth, the consumer losses from tariffs must outweigh the producer and government gains. The massive stock market decline that followed the tariff announcement — the biggest since the COVID-19 pandemic hit in March 2020 — backs up this claim.
One might ask: Isn’t it better to restrict imports, so that we become more independent economically? Well, the road to economic independence is the road to poverty. Tom Hanks’ movie “Castaway” taught us that. His character had to make all of his own clothes, produce all of his own food and do all of his own dental care. Imagine the clothes you’d wear, the food you’d eat and the dental care you’d get without access to thousands of foreign goods that you consume each year (many things in a dentist’s office come from China). Getting lower prices through imports is like getting a raise: You have more money to spend on other needed things.
Better tools to boost U.S. production
Given the widespread harm tariffs can cause, it is not surprising that we have better ways of reaching the tariffs’ goals.
We have better ways to help domestic producers. Subsidizing them would bring the same benefits at lower cost. Subsidizing does mean that, instead of collecting tariff revenue, the government would spend money on producers, but subsidies would not raise prices to buyers.
The resulting gains to consumers (from not facing higher prices) would far exceed the subsidies’ costs, making subsidies a cheaper way to bring the same gains to domestic production.
We also have better ways of shrinking our trade deficit. Tariffs won’t likely do this well, because remember: Tariffs raise costs for all, including exporters. Thus, tariffs hinder exports as well as imports and, in the end, do not shrink trade deficits.
Trade deficits result from nations consuming and investing more than they produce and save. Replacing the income tax with a national sales tax could shrink the trade deficit, since the former taxes income that is saved, while the latter taxes only consumption.
We have better ways of dealing with bilateral deficits: Ignore them. Shrinking bilateral deficits is not a reasonable goal, since they reflect fundamental differences in production capacities and consumer tastes that no policy can change.
I have a permanent deficit with my barber: I have spent thousands of dollars on his haircuts, but he has never once asked me for an economics lecture. This bilateral deficit blesses us both.
Likewise, nations should not seek to eliminate bilateral deficits with each other. A more reasonable goal would be to get other nations to reduce their trade barriers.
Here again, tariffs are a bad tool. Threatening tariffs against nations because of our deficits with them undermines the multilateral trading system that has brought great gains to the global economy since the world embarked on freeing trade after World War II.
We are already seeing other nations threaten retaliatory tariffs, thus launching an all-out trade war that would multiply tariffs’ collateral damage. Good faith negotiations would bring better results at lower costs.
We have better ways of raising revenue. Taxes create economic distortions by reducing the quantity sold, which, as discussed above, shrinks wealth. In general, that distortionary cost gets ever worse as the tax rate rises. (More technically, taxation’s marginal cost rises.)
This means that it is better to raise a given amount of revenue by taxing a large section of the economy at relatively low rates than to tax a small part of the economy at relatively high rates. In other words, it’s better to have a broad tax base than a narrow one.
The tariff executive order, though, does the latter: Imports comprise less than 20% of our economy and thus constitute a narrow base, and the proposed rates are quite high.
The Trump administration should put the sledgehammer down and look for tools better suited to building a strong economy.