Speculation about potential tariffs has captured headlines recently, however, the use of tariffs is hardly a new tactic. After the ratification of the US Constitution, one of the first major pieces of legislation was the Tariff Act of 1789 which imposed a 5% tariff on nearly all imported goods. In fact, until the implementation of income taxes in 1913, tariffs were one of the primary funding sources for the US government. Following World War II, tariffs largely fell out of favor in advanced economies because they often led to reduced trade, higher prices for consumers, and retaliation from abroad.
Back in 2018, President Donald Trump broke with this economic orthodoxy and imposed substantial tariffs on imported goods from China and other countries with the goal of combating unfair trade practices, reducing the US trade deficit, and boosting domestic manufacturing. While the Biden administration sharply criticized Trump’s tariffs, they ultimately kept most of the 2018 tariffs in place. Taking it a step further, Biden imposed new tariffs on imports of electric vehicles from China, justifying them on the grounds of national security and unfair domestic subsidies from Beijing. As markets prepare for a second Trump administration and promises to further expand tariff policy, many economists and investors are concerned about the ripple effects now that tariffs have resurfaced as a significant part of the US trade landscape.
What are Tariffs? And, Who Pays?
A tariff is a type of tax imposed on goods when they cross national borders, often used by governments to protect domestic industries or as leverage in negotiations with trading partners. This additional tax makes imported goods more expensive, ostensibly providing a price advantage to local producers, while also raising revenues for the government.
Over the course of 2023, the US imported approximately $3.1 trillion of goods, equivalent to ~11% of our GDP.[1] Tariffs imposed on those imports brought in $80 billion of revenue paid by the US firms importing the goods. While that is a substantial amount of money, it only equates to 2% of total US tax revenues.[2]
While importing companies pay the upfront costs, the question of who ultimately pays the tariff costs is more complicated. If the importing firm passes the cost of the tariff on in the form of higher retail prices, US consumers will bear the economic burden. If the importing firm absorbs the cost of the tariff itself and doesn’t pass it on, that company (along with its shareholders) bears the economic burden in the form of lower profits and slower growth. Lastly, it is possible that foreign exporters lower their wholesale prices by the value of the tariff to retain access to their US customers. In that scenario, the exporting firm bears the economic burden of the tariff in the form of lower profits.
While all three stakeholders often bear some of the costs, economic studies of tariffs imposed between 2017 and 2020 suggest the majority of the economic burden was ultimately borne by US consumers.[3]
Are Tariffs an Effective Policy Tool?
The answer to this question entirely depends on how you define the purpose of the tariffs. If the intention is lowering inflation, stimulating the economy, or protecting domestic industries, the economic data shows tariffs to be an ineffective tool, often creating negative ripple effects. If the goal is to use tariffs as a negotiating tactic or to address specific national security concerns, the effectiveness is open for more substantive debate.
Tariffs are often touted as a way to protect and create US jobs, but recent data doesn’t back this up. The Trump administration imposed 25% tariffs on imported steel in 2018 to protect US producers. By 2020, total employment in the US steel sector was 80,000, down from the 84,000 it had been in 2018. It is theoretically possible that employment might have dropped further without the tariffs, but detailed economic studies have shown no positive employment impact for the US steel industry.[4] On the contrary, economists found evidence suggesting that higher steel prices following the tariffs led to lower employment in other US manufacturing sectors. Related businesses that relied on steel as an input, including the agricultural machinery manufacturer Deere & Co, were forced to reduce headcount to offset rising production costs.
Retaliatory tariffs add a complicating factor. Shortly after tariffs were imposed on Chinese imports in 2018, China responded by putting tariffs on imports of American soybeans and corn. That move hurt American farmers, who relied heavily on business with China. In the subsequent years, the US government ended up bailing out farmers who saw their export revenue drop significantly. A study by the Council on Foreign Relations calculated that 92% of the proceeds from tariffs on Chinese imports were ultimately spent on payouts to farmers.
It is much harder to quantify the effectiveness of tariffs as a negotiating tactic on the geopolitical stage. The incoming administration will be negotiating a new US-Mexico-Canada trade deal (formerly NAFTA) in 2026, and it’s likely current tariff threats are being used to set the stage for these negotiations. Additionally, there are manufacturing sub-sectors and specific supply chains (such as rare earth metals) that do have national security and defense implications, and it’s in the US’s interest to support these industries domestically.
Within this complicated landscape of factors, one thing is clear, the majority of the costs of tariffs are borne by consumers.
New Chapter, But a Familiar Story
While investors are expecting an uptick in drama-filled political negotiations and a return to the chaotic communication from Trump on X or Truth Social, we also want to remember that the global economy still accomplished meaningful growth despite tariffs under both the first Trump administration as well the Biden administration. There are novel factors with every new chapter in political and economic cycles, but the global economy has consistently proven to be adaptable and resilient.
It is also helpful to remember that political rhetoric does not always translate into actionable policy. Until specific measures are implemented, a significant level of uncertainty remains. In our pre-election article, Investing and Elections: What History Tells Us, we highlighted multiple examples where the market delivered outcomes that differed from political expectations. In each of these historical chapters, remaining steadily invested in a diversified portfolio of equities with regular rebalancing often led to the best outcomes. While we share some of the inflationary concerns related to potential tariff legislation, we are confident that multinational companies based in the US and around the globe have already been preparing for these scenarios and will adapt as a new landscape emerges.
Resources
1 Gross Domestic Product [GDP]. Federal Reserve Bank of St. Louis
2 Federal government current tax receipts. Federal Reserve Bank of St. Louis
3 The Economic Impacts of the US-China Trade War. National Bureau of Economic Research
4 Help for the Heartland? The Employment and Electoral Effects of the Trump Tariffs in the United States. MIT
