by Erica York at Tax Foundation
President-elect Trump has promised to impose steep new taxes on trade, including a 10-20 percent tariff on all imports, at least a 60 percent tariff on Chinese imports, and a 25-100 percent tariff on Mexican imports. At least a dozen estimates on Trump’s proposed tariffs show they will have a harmful effect on the American economy, supporting the standard view among economists that tariffs reduce trade and distort production, leading to lower standards of living.
A tariff is a tax on imported goods, applied at the border when a business or person in the US purchases a good from abroad. Tariffs increase the price of foreign-produced goods, incentivizing consumers to switch to domestically produced goods and providing domestic producers room to increase their prices. The benefits that domestic producers receive, i.e., higher prices and sales, come at the expense of consumers (including business consumers). For this reason, tariffs are redistributive, taking income from some and giving it to protected businesses.
While the protected businesses may grow because of the tariff, they are not low-cost producers. Thus, tariffs result in less efficient production, leading to reduced economic output and lower incomes over the long run. This is the standard analysis of tariffs going back to Adam Smith and the classical economists, who recommended keeping tariffs as low as possible (tariffs were a primary source of government revenue at the time).
The debate has its nuances, such as the potential impact of tariffs on the price level. Tariffs could have an inflationary impact or cause an economic downturn in the short run, depending on whether the Federal Reserve takes action to loosen policy and accommodate the tax increase (we’ll discuss these questions in a forthcoming analysis). But no matter whether the short-term adjustment involves inflation or temporarily heightened unemployment, the long-run adjustment to tariffs involves lower incomes and production.
Over the long run,…
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