My Answers to Some of Your Questions About Tariffs
Economists of all stripes are currently “enjoying” a respite from answering questions from friends and family about what the stock market is going to do. We’re getting questions about tariffs instead.
I’m totally here for it!
What is a tariff and who pays it?
Tariffs are taxes paid by importers of foreign goods. What matters, however, is not who writes the check to the government, but who ultimately bears the cost. The bearer of the cost will be some combination of American buyers (paying higher prices), and foreign and American sellers (receiving lower prices). There can also be exchange rate effects — I’ll get to that later.
Imagine you import $100 worth of toys from China. At present, you would have to pay a $145 tariff to the US government. Let’s consider your options.
You may be able to charge a higher price to your customers. There have already been numerous media stories of companies adding “import charges” onto products such as clothing and bikes. This will work only if your customers cannot easily shift away from your product. If they can shift to another product, then raising the price would serve only to chase away customers and you won’t do it.
Another possibility may be to avoid the tariff by finding a comparable supplier in a non-tariffed country. Alternatively, perhaps your Chinese supplier has no other markets that it can sell into and will accept a lower price. If your Chinese supplier will sell to you for $20 instead of $100, then you can put the savings towards the tariff. Or maybe you have been selling the toys for $300. You can pay the tariff and still make a profit without changing prices. If you can’t make any of these scenarios work, then you will go out of business.
Bottom line: The people hit hardest will be the ones with the least ability to pivot to another product or market. In short, it’s all about elasticities, arguably the most important numbers in economics, as explained here by The Wire’s Stringer Bell.
What are tariff rates at present?
Nobody knows. That’s a joke. A few people know, but there have been numerous changes, and it’s hard to keep track. Most of the “liberation day” tariffs have been paused until July 8, but the massive tariffs on China remain mostly in place. This tracker has all the details. The uncertainty has made investors and business leaders uneasy.
The 145% tariff on Chinese goods went into effect for ships departing after April 9. Those ships will start arriving on the West Coast next week. I expect that there will be many fewer of them than usual. The ones that would have carried products with elastic demand (e.g., toys) will have stayed home; those carrying inelastically demanded products (e.g., car seats, some manufacturing inputs) will arrive and buyers will pay a large premium for the goods on them.
Have other countries been ripping us off?
If I buy an imported bike for $1000, then that bike must be worth more than $1000 to me. Otherwise I would not have bought it. Similarly, the bike must worth less than $1000 to the seller. Otherwise they would not have sold it. The bike company bought nothing from me, yet the bike transaction made us both better off. This is an example of what we call gains from trade.
President Trump asserts that other countries are “ripping us off” when we buy more stuff from them than they buy from us. This is wrong because of gains from trade; we’re buying the extra stuff because we want to buy it.
Let’s follow the money. In 2024 Americans bought $440 billion of stuff from China, and Chinese bought only $140 billion of stuff from America. So, at the end of the year, America had $440m of stuff, and China had $140b of stuff and $300b in cash.
What did they do with the cash? Answer: they invested it. And, because these are American dollars, they invested in American assets such as stocks and bonds. They’re making a bet that the US economy is safe and will grow.
One could just as easily argue that we are ripping them off. They send us a bunch of stuff that we get to consume and they also invest in the future growth of our economy. Sounds like a win-win. It’s one reason America is the richest large country in the world.
Isn’t a tariff just a sales tax?
Yes, but it’s a sales tax on a subset of goods, including many intermediate goods. These features make it a really bad tax. The government needs to raise revenue and should seek to do so in the least disruptive and fairest way possible. Typically that means a broad base and low rates so that the playing field remains level. The Trump tariffs are not that.
Tariffs on intermediate goods like car parts and lumber make domestic production more expensive and less efficient. If the goal of your tariffs is to promote domestic manufacturing, then you’re shooting yourself in the foot if you make it harder for domestic manufacturers to do business by raising their costs.
Placing taxes only on imported goods and at differential rates depending on the country raises costs and makes us poorer. It also becomes a nightmare to administer. The US tariff schedule includes 12,000 items for trade with almost 200 countries — that’s 2.4 million entries. Separate tariffs on each row would requires a lot of government employees to administer.
Lesson number 6 in Optimal Taxation in Theory and Practice by Mankiw, Weinzierl, and Yagan sums it up:
Lesson 6: Only Final Goods Ought to be Taxed, and Typically They Ought to be Taxed Uniformly
What’s the big deal? Haven’t we always had tariffs?
We have not imposed tariffs this high in more than a century. The Yale Budget Lab reports that:
The April 2nd action is the equivalent of a rise in the effective US tariff rate of 11 ½ percentage points. The average effective US tariff rate after incorporating all 2025 tariffs is now 22 ½%, the highest since 1909.
It is fair to reciprocate tariffs though, right?
Fair to whom? Tariffs may benefit American companies, but they make American consumers poorer by increasing prices. This is true regardless of whether the other country has tariffs.
An American clothes washer company may cry foul if, say, Korea were to assess a tariff on American washing machines because it would put them at a competitive disadvantage in Korea. They may see it as fair if Korean washers faced a similar tariff coming into the United States.
However, American consumers would certainly not appreciate paying more to wash their clothes. A reciprocal tariff makes them poorer. This is exactly what happened when the US imposed tariffs on washers in 2018. The prices of imported and domestic washers went up. And so did the price of dryers!
Of course, the “reciprocal tariffs” announced by the Trump Administration on April 2 weren’t actually reciprocal tariffs because they weren’t based on foreign tariff rates on American goods. (Instead, they were “justified” by an erroneous formula.)
Why shouldn’t we be self sufficient?
See the above answer on gains from trade. If people, companies, and countries focus on what they are relatively better at, we can all be better off. Perhaps the American washer and dryer companies would be better to devote their talents to something different. I could grow my own food, but not doing so frees up time to do economics, which I’m better at. We make ourselves poorer if we bring low paying jobs to the US: Americans want to wear Nikes, not make them.
There are a couple of caveats here. First, national security. One can argue that we should avoid enriching a geopolitical rival like China, and that we should produce of critical products ourselves in case we end up in a war against our supplier. But this is an argument for investing directly in production of these products, not for tariffs (and especially not for tariffs that change by the week).
Second, what about the people and communities that lose jobs and businesses to lower-cost foreign producers? This is a real issue, not just with import competition, but also with automation, artificial intelligence, and other progress that leaves some people behind. Again, this is an argument for policies to help those left behind, not for tariffs to gum up the economy.
But wouldn’t it be better for America if more people worked in factories?
Even if you believe this, and to repeat myself, it is an argument for investing directly in production of these products, not for tariffs (and especially not for tariffs that change by the week).
I am intrigued by the movement on the new right to venerate factory jobs, as though life would be better if men took their lunch pails off to work in a factory every day like they did in the 1950s. People forget that we were a lot poorer then and those were often terrible jobs.
It reminds me of the nostalgia we have for farming. People move out of agriculture as countries get richer, yet governments in rich countries tend to support farmers with large subsidies. In the most recent example, the Trump Administration is set to reprise its 2018-19 trade war (over) compensation payments by compensating soybean farmers for as yet non-existent trade war losses.
There are competing theories to explain this phenomenon, including that farmers are a concentrated interest group with powerful lobbyists and that political representation skews rural. But I think nostalgia is a powerful driving force. Most people have ancestors who were farmers, many of whom had to leave their farm when dramatic productivity improvements forced out small farmers in the middle of the 20th century.
Won’t exchange rates adjust so we don’t have to pay higher prices for imports?
Welcome to the macroeconomics part of the article. I can feel your eyes glazing over, but hang in there.
New Zealand exported about $480m of wine to the US in 2023. At 2023 exchange rates, New Zealand wine makers could convert those $480m into 797m NZ dollars.
On “liberation day,” the US placed a 10% tariff on goods from New Zealand. Suppose the exchange rate increased so that each US dollar was worth 10% more NZ dollars? New Zealand exporters could charge their US customers 10% less and still have the same amount of money once they convert it back into New Zealand dollars. With the drop in prices, American importers could pay the tariff and still be spending the same amount as before.
That sounds great, except the more expensive US dollar means that American exports would now be 10% less attractive to New Zealand buyers. Exchange rate adjustment is a way to shift the pain of tariffs onto exporters, which seems counterproductive if the goal is to help American companies export more.
Did exchange rates actually move in response to the current tariff increases? The US dollar appreciated by 5% against the NZ dollar after liberation day, which equals half the tariff increase. It then dropped by 5% when the tariffs were paused a week later. This response is consistent with economic understanding of the effects of tariffs on small open economies like New Zealand (going all the way back to Mundell (1961)).
Things are more complicated for large currencies, where capital flows dominate exchange rate movements. For example, the US dollar exchange rates with the Euro and the Chinese Renminbi barely moved on “liberation day”. Remember that $300b in cash that he Chinese invest in the US? Their willingness to make such investments will drive exchanges rates more than the relative flow of goods.
OK, but what’s the worst thing about tariffs?
Corruption. Tariffs are set by the president using power delegated to him by Congress, which opens the door for businesses and politicians to lobby for special treatment. It is easy to imagine a leader using tariffs to give out political favors and punish political enemies.
The CEO of Apple successfully got a reprieve from tariffs for smartphones. Many other business leaders have followed suit in making pleas for mercy. In the 2018 tariff war, the Office of the US Trade Representative openly allowed domestic companies to request special exclusion for specific products. Leaders from many nations are looking to make deals with the president on their own tariffs. Expect lots of side deals and you-scratch-my-back-and I’ll-scratch-yours shenanigans. This stuff is corrosive to a well functioning economy.
I fear that it’s only just beginning.