How Tariffs Will Affect the Economy

The Trump administration threatened to impose 25 percent tariffs on imports from Canada and Mexico on Feb. 1, delayed those tariffs by a month on Feb. 3, imposed them on March 4 and then delayed them another month on March 6. Meanwhile, tariffs have been imposed on Chinese goods, 10 percent in February, which was then raised to 20 percent on March 4. All this has left Americans wondering what to expect. Fortunately, both economic theory and history give us a pretty good idea of what effects tariffs would have on the U.S. economy.

A tariff is a tax and has the same effect as a tax on any other product such as cigarettes or gasoline. A tax puts a wedge between the price sellers receive and the price producers pay. In general, the price to consumers goes up and the price received by sellers goes down, though the allocation of the price change is determined by the demand and supply curves.

Economists usually assume that a country putting a tariff on a goods is facing a competitive world market and therefore consumers pay most of the tax. Indeed, a study of the 2018 tariffs shows that “close to all” of the tariffs were passed on to consumers in the form of higher prices.

Taxes also reduce the quantity of goods sold, so tariffs will reduce the quantity of imports. Domestic companies competing with imports will sell more of their goods, but companies using imported inputs will be hurt. For example, a steel tariff, by raising the price of steel, helps domestic steel producers but hurts domestic car manufacturers who purchase steel.

Tariffs also raise revenue, but the losses to consumers are greater than the revenue raised by the tariffs. Tariffs may also reduce growth because companies who are protected from competition have no reason to innovate.

Economists have studied the effect of the tariffs imposed by Trump in 2018 and estimate that the costs of tariffs to purchases of the products were $23.8 billion during the year, of which $15.6 billion went to the government as tariff revenue and $8.2 billion was lost to the economy.

History also alerts us to the secondary effects of tariffs. When one country places a tariff on the goods of another country, that other country usually responds with tariffs of its own. The result is a tariff war that reduces trade between the two countries and results in loses to economic growth for both of them. In the 1930s, Europe responded to the United States’s Smoot-Hawley tariff by increasing tariffs on U.S. goods, reducing their imports of U.S. goods by about a third. In 2002, the European Union responded to President George W. Bush’s steel tariffs by imposing tariffs on oranges and cars, targeting products from swing states.

This time will not be any different. China has already imposed retaliatory tariffs on U.S. goods: 15 percent on chicken, wheat, and corn, and 10 percent on soybeans, beef, and fruit. Canada has imposed its first wave of retaliatory tariffs on orange juice, peanut butter, coffee, appliances, footwear, cosmetics and motorcycles. In response to tariffs on steel and aluminum, the European Union has announced tariffs on U.S. goods to take effect April 1, including a 50 percent tariff on bourbon. U.S. exporters will lose business, and these losses are in addition to the direct costs of the tariffs to U.S. consumers.

What about the trade deficit? While people worry that the U.S. imports more than it exports, tariffs will not change this situation because they do not address the underlying cause of the deficit. The trade deficit is the result of the fact that foreigners buy lots of U.S. bonds. If someone outside of the U.S. wants to buy a U.S. bond, they have to first obtain dollars. If people in the U.S. don’t want to buy their bonds, they have to sell us goods and services in order to obtain the dollars they want. On net, the U.S. imports goods and exports bonds. A tariff on imports won’t change the demand for U.S. bonds, so it won’t reduce the trade deficit.

The League of Women Voters is a nonpartisan, multi-issue political organization which encourages informed and active participation in government. For information about the League, visit the website www.lwvmontcoin.org; or, visit the League of Women Voters of Montgomery County, Indiana Facebook page.