Barnett and Company

Personal Finance: Understanding tariff policy

For the past two years, the United States has engaged in an escalating trade war in which there are no winners. One of the most thoroughly settled tenets of economics is that encumbrances to trade inflict damage upon the trading partners that can take years to unwind and cause living standards to fall.

President Donald Trump has stated, “tariffs are now being paid to the United States by China of 25% on $250 billion” worth of goods. This is erroneous, but the fact that the author of the tariff policy lacks a basic understanding of their operation suggests a fuller discussion is warranted.

A tariff is a form of taxation on imported goods. Such levies are as old as commerce itself, and have been used primarily for two purposes: sheltering native industries from competition, and raising revenue. In the United States, import duties were the primary source of revenue until the 16th amendment established the constitutionality of the income tax in 1913. Since the Bretton Woods agreement in the wake of World War II, trade barriers have declined steadily, producing both a more prosperous world and a significant reduction in geopolitical conflict.

Enter the Trump administration, which began imposing tariffs on goods imported to the U.S. as a cudgel to punish partners for the offense of selling us the products we wish to consume. Last Friday, the administration upped the ante, raising the tax from 10% to 25% on a variety of Chinese imports. China, naturally, has announced planned retaliation. Guess who gets caught in the crossfire.

Who actually pays the tariff? The president mistakenly said China pays. That belies a misunderstanding of the mechanism by which the levies are collected. Recall that a tariff is a tax, imposed upon the importer of the products and not upon the exporter. U.S. businesses and households pick up the tab directly via the higher after-tax prices of these goods. Consider the analogous case of a sales tax. When you buy a $20 shirt at Walmart, your final price of $21.85 includes the sales tax added to the transaction. The manufacturer does not foot the bill. You do.

China is, in fact, not paying into the U.S. Treasury; American consumers are. And those duties are starting to bite.

Ostensibly, the tariff policy is intended to reduce the trade deficit, although the economic justification for doing so remains unconvincing. Trade deficits are normal for relatively wealthy, high-consuming countries like the United States.

Meanwhile, Americans are beginning to feel the heat. A study by the New York Fed suggests tariffs through 2018 have resulted in a decline of $1.4 billion in real income on average every month. Another paper by the World Bank estimates those taxes have reduced overall U.S. output by $7.8 billion, much of which has come from the most vulnerable economic areas of the country. The early tariff on washing machines alone caused the average price to increase by 12%.

Tariffs also promote inefficiency. Vigorous competition is essential to innovation and cost containment. That is no mere theoretical hypothesis. We have witnessed numerous real-time examples over the past 50 years of policy errors that sheltered U.S. industries from competition, inducing inefficiencies, and raising prices to households.

The prospects for correcting our current course seem bleak at present, and one must expect China to fight back with reciprocal action, accelerating the downward spiral of income and economic growth. Here’s hoping someone in Washington dusts off an old Economics 101 textbook.

Christopher A. Hopkins, CFA
Vice President and Portfolio Manager
Barnett & Company

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