The Incoherent Case for Tariffs

Less than two months into his second term, U.S. President Donald Trump has made good—with startling intensity—on his campaign promise to impose tariffs. On inauguration day, he issued the America First Trade Policy Memorandum to review U.S. trade policy with an eye toward a new tariff regime. Over the first two weeks of February, he set in motion new duties covering nearly half a trillion dollars of U.S. imports. On March 4, he doubled the size of his already significant February tariff increase on China. Over this period, he has also announced, suspended, announced again, and suspended again 25 percent tariffs on goods from Canada and Mexico. And his administration has pledged to impose reciprocal tariffs on April 2.

The result has been uncertainty, chaos, and immediate retaliation from some of the United States’ biggest trade partners. All this economic upheaval raises a central question: Why is Trump so focused on tariffs? They are a longtime obsession. When he declared in his second inaugural address that “we will tariff and tax foreign countries to enrich our citizens,” Trump was echoing, almost verbatim, comments from his first term. Trump’s view seems to be that tariffs can be used to fix anything. They can raise tax revenue from foreigners to replace domestic taxes, eliminate the trade deficit by rebalancing trade, ensure reciprocity so that other countries impose lower tariffs on U.S. exporters, reshore manufacturing jobs to the United States, protect national security and end dependence on adversarial suppliers, and punish countries for unrelated sins, such as failing to stop migration.

Tariffs can, in fact, sometimes help achieve some of these objectives. Targeted tariffs can be a useful instrument to shift sourcing away from unfriendly countries. But they are almost never the best policy to tackle the challenges that concern Trump. And given the complex, interconnected nature of these problems, using tariffs to fix one of them could hamper the country’s ability to solve another.

The Trump administration should instead make use of a fuller inventory of economic policies. Its potential toolbox is huge and includes such strategies as working with allies to diversify supply chains for critical industries, reducing the fiscal deficit, and changing the U.S. tax code so it diminishes corporations’ incentives to offshore production or even encourages them to create manufacturing jobs. So many of the problems the Trump administration identifies in the U.S. economy have their origins at home. Beating up trading partners not only fails to solve these underlying problems; it also harms the U.S. economy while fostering foreign resentment and retaliation that compound the damage.

A DROP IN THE BUCKET

Trump is correct in his assertion that tariffs raise government revenue. But they do so inefficiently compared with other taxes. Unlike tariffs, alternative forms of taxation collect large amounts of revenue and impose few economic distortions—particularly forms of taxation that apply low tax rates to a large tax base. There is no way that tariffs could replace them as a revenue source. For example, in the 2024 fiscal year, the U.S. federal government spent a total of $6.4 trillion. Yet in 2024, the United States imported only $3.3 trillion worth of goods. Even a 100 percent tariff on all imported goods would not be enough to finance the federal government, and any tariff on that level would also severely cut imports, dramatically reducing U.S. revenue and inflicting enormous costs on the economy.

By contrast, some 60 percent of the federal government’s revenue has in recent years come from personal and corporate income taxes. Americans’ personal income, which totaled $24.7 trillion in 2024, combined with corporate income make up a much larger tax base and will not shrivel as fast as imports when hit with taxes. Setting aside the negative impact of tariffs on economic growth, even if Trump were to carefully select the duties that maximize tariff revenue and impose tariff rates at a staggering 50 percent, tariffs would bring in only 40 percent of the revenue generated by current U.S. income taxes on individuals and corporations, according to analysts at the Peterson Institute for International Economics. The distortionary costs of such tariffs would be far greater. And this estimate ignores potential retaliation by trading partners, which could further slow U.S. economic growth by hurting exports.

Tariff proponents might respond that import duties are paid by other countries, whereas domestic taxes are paid by Americans. But this line of argument ignores the actual effect of tariffs on consumers. In fact, multiple independent studies of Trump’s first-term tariffs found that importers passed along the effect of border taxes to U.S. businesses and households. In the end, Americans paid the tariffs, not foreign companies. The sweeping scope of Trump’s new tariff proposals could make them even more painful for American consumers. They strike at two of the United States’ largest and closest trading partners, Canada and Mexico—countries from which the United States imports everything from energy products to food and automobile components.

DEFICIT DISORDER

Trump has long believed that the U.S. trade deficit is an indication that Americans are getting ripped off by other countries. Most economists maintain that this interpretation reflects an inaccurate understanding of trade imbalances. But accepting the idea that reducing the American trade deficit is a national priority, it would seem that tariffs, by reducing imports, would also reduce the deficit, as long as nothing happens to exports.

But tariffs do have consequences for exports. Higher U.S. tariffs increase the value of the dollar because Americans cut back on purchasing imported goods. And a stronger dollar, in turn, raises the price that foreigners have to pay for U.S. exports, thereby diminishing their competitiveness. Tariffs also lead to foreign retaliation, further denting exports; Trump’s new tariffs have already led China to strike back against U.S. sales of soybeans, farm equipment, cars, and liquefied natural gas with tariffs of their own. For these reasons, empirical studies have shown that tariffs are generally an ineffective way to change the trade balance.

Most important, tariffs do not affect the underlying macroeconomic factors driving trade deficits. A country’s trade balance is determined by its balance of saving and investment. A country such as the United States, with a low rate of savings and a high rate of investment, is practically assured to have a trade deficit, given the capital inflows from abroad needed to finance that investment. People in other countries who earn dollars from Americans buying their goods tend to use those dollars to purchase U.S. assets, including stocks, bonds, and real estate, rather than U.S.-made manufactured products.

Tariffs are an ineffective way to change the trade balance.

Unless U.S. savings rise relative to investment, tariffs will not directly reduce the trade deficit. In fact, if tariffs lead to more foreign investment as factories are brought back to the United States—another stated goal of Trump’s tariff regime—that inflow of capital could lead to a larger trade deficit as foreigners with dollars gain even greater incentives to buy U.S. assets rather than goods or services.

If reducing the trade deficit is Trump’s goal, his administration would do better to focus its efforts on shrinking the federal budget deficit, a major source of excess spending in the U.S. economy. If it succeeded, federal borrowing would drop, interest rates would decline, and foreign capital would be less attracted to U.S. assets.

Other policies could also increase savings. The U.S. tax code has typically encouraged consumption rather than savings; shifting its balance of incentives would help reduce the capital inflows that help drive the trade deficit. A more draconian approach could be to tax foreign purchases of U.S. assets, which would reduce the trade deficit but lead to higher U.S. interest rates, a tradeoff that may not be worth it, including to Trump.

DO UNTO OTHERS . . .

Trump wants reciprocity in tariffs: “If they charge us, we charge them,” he said in February; he has promised to release a plan for reciprocal tariffs in April. His February Reciprocal Trade and Tariffs Memorandum reflected the belief that other countries levy higher tariffs on U.S. exports than the United States levies on their goods. This is often true, but not nearly by the margin that he and most of his supporters believe. For example, the average tariff EU countries apply to U.S. products is just 5.0 percent, not far from the average U.S. tariff on products from Europe of 3.4 percent.

The tariffs that the United States and its trading partners impose are not identical because, historically, U.S. negotiators strove for reciprocity in the changes the United States and its trading partners made to their tariff levels—but not for the equalization of the tariffs themselves. From the 1940s to the 1990s, when the United States, European countries, and others agreed to cut the tariffs they applied to one another, the change in market access resulting from those cuts was balanced, but the final tariffs, on a product-by-product basis, were not.

Now, Trump sees the threat of higher U.S. tariffs as a bargaining chip (or cudgel) to make other countries reduce their tariffs down to U.S. levels. Yet it is fair to ask whether Trump’s concerns about reciprocity are made in good faith. Many countries already have lower tariffs than the United States on certain goods: Japan’s automobiles, Europe’s trucks, New Zealand’s dairy products. It is doubtful that Trump’s commitment to reciprocity includes a willingness to match those tariffs.

Even if a country negotiated reciprocal tariffs with Trump, he could demand more, often nontrade-related concessions, as he has when announcing some of his latest tariffs. The United States had reciprocal tariffs of zero percent with Canada and Mexico. But he bullied them into renegotiating the North American Free Trade Agreement (NAFTA) into the U.S.-Mexico-Canada Agreement during his first term, only to threaten (and then partially retract) 25 percent tariffs on those same countries in his second term as punishment for what he considered insufficient investment in border security and enforcement against fentanyl trafficking. In January, he threatened Colombia, with whom the United States has had reciprocal zero tariffs since 2012, with a trade war after Colombian President Gustavo Petro objected to the United States’ use of military planes to transport deportees. Furthermore, when Trump pulled the United States out of the Trans-Pacific Partnership in 2017 (arguing, without explanation, that it was an unfair trade agreement), he effectively gave away the ability of U.S. exporters to receive zero tariffs—and reciprocity—from trading partners such as Japan, Malaysia, and Vietnam. For all his belief in the power of reciprocal tariffs, Trump does not appreciate the value of free trade agreements that guarantee zero tariffs on both sides.

FACTORY SETTINGS

In Trump’s eyes, fixing trade imbalances and boosting jobs are inseparable—despite the fact that at any given moment the unemployment rate is determined by macroeconomic forces and Federal Reserve monetary policy, not trade policy. But Trump’s main focus is not the number of jobs the United States has on offer (the current unemployment rate is about four percent, a low level in historical terms) but their kind. He has repeatedly promised to create more jobs for blue-collar workers in manufacturing industries.

There are several problems with Trump’s hope that imposing tariffs will create factory jobs. For any given industry, tariffs do act as a subsidy, but they subsidize domestic production, not employment. Today, manufacturing production is increasingly intensive in inputs such as machines, robots, and other technology, not human labor. A new semiconductor factory, for example, may cost $20 billion to construct but ultimately operates using few workers, aside from highly trained engineers. Tariffs may thus bring new plants, but not necessarily the jobs that might have once come with them.

Tariffs also act as a tax on consumption, raising prices on final products for households. And for tariffs on intermediate inputs such as steel, the effect is worse: they can actually work against the creation of manufacturing jobs by prioritizing workers in one industry at the expense of those in others. The economists Kadee Russ and Lydia Cox have estimated that for every new job created in a U.S. steel mill benefiting from tariff protection, 80 workers in downstream industries that use steel would be hurt. The industries that have to use more expensive steel as an input, such as automobiles, machinery, and farm equipment, would become less competitive compared with foreign rivals that can access cheaper steel. Thus, Trump’s first-term tariffs were found to have harmed overall U.S. manufacturing employment. And his current plans to impose tariffs on imported steel, aluminum, and automobile parts across North America will result in much higher costs for cars produced in the United States.

Tweaks to the U.S. tax code would more directly incentivize firms to hire more workers in manufacturing. The American tax code currently encourages offshoring by taxing foreign corporate income at a rate lower than domestic corporate income. Trump could also cut the payroll tax, which tends to discourage companies from hiring workers, for manufacturing firms. But any effort to revive U.S. manufacturing jobs will face significant headwinds. The share of workers in manufacturing is declining in most industrialized economies; as populations become wealthier, they can afford to spend more on services such as education, health care, and leisure provided locally. Job growth is likely to continue to shift away from manufacturing and toward those sectors, with or without tariffs.

ALONE IN THE FUTURE

Finally, Trump hopes to shore up U.S. national security by using tariffs to promote the domestic production of goods in critical industries. He has floated possible tariffs on semiconductors, including on imports from Taiwan and South Korea. Tariffs implemented on foreign chips that result in higher prices, even if they incentivize investment in U.S. semiconductor capacity in the future, could deal a huge blow to semiconductor users today. When the United States tried a similar protectionist strategy to spur domestic technology production in the late 1980s, it pushed its laptop industry overseas to Asia, where the cost of both labor and other components was lower. Today, this would prove especially problematic for the burgeoning AI industry, which requires semiconductors in massive volumes to power data centers.

In the defense and national security sectors, the buyers of the goods are sometimes just as important as the producers. Targeted subsidy policies aimed at diversifying the United States’ tech supply chain outside China, such as the CHIPS Act, can be less costly to companies that need semiconductors for their products than import tariffs are, even if industrial policy does require the government to get involved in “picking winners.”

This is where subsidy cooperation with allies and partners can help to diversify risk, share costs, and create collective protections against common adversaries. The Biden administration tackled the practicalities of coordinating industrial policy in different ways. For chips, it worked with allies to develop a more resilient semiconductor industry outside China, including by cofinancing the build-out of new chip-fabrication facilities in Dresden, Germany, Kumamoto, Japan, and Phoenix. For critical minerals such as lithium, cobalt, and graphite, the United States developed the Minerals Security Partnership to pool resources with the European Union, Japan, Korea, and other like-minded countries to incentivize mining and processing outside China. Trump, so far, does not appear to be willing to partner with allies in this way, and in his joint address to Congress in March, he called for the repeal of the CHIPS Act.

ADMITTING SELF-DEFEAT

Tariffs can be used to achieve some national targets, but they are rarely the best instrument to achieve them. Even when they work, they are often inefficient and cause considerable collateral damage. The foreign retaliation they invite can reverse any initial benefits they might yield. And economists are particularly skeptical about using tariffs to achieve multiple objectives at once, as Trump apparently wants to do.

Less than 48 hours after the imposition of the latest tariffs against Canada and Mexico, Trump walked most of them back. This on-again, off-again tariff policy is especially poorly designed to achieve any of the objectives that Trump wants. The stock market has reacted negatively, and key U.S. industries are fearful of the chaos likely to ensue when companies in their supply chains cannot afford the sudden cost increases that could come when the tariffs are reimposed. If the administration ultimately follows through on Trump’s many other threats, the effect will be far more disruptive than the “little disturbance” to the American economy he predicted in the March address.