“Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.” Benjamin Franklin, November 1789, in a letter to Jean-Baptiste LeRoy.
A united government—control of the White House and both houses of Congress—will be installed next month, and with it comes the promise of a new approach to trade policy. Incoming President Trump made tariffs a cornerstone of his America First economic policy, going so far as to say that the word “tariff” was more beautiful than the word “love.”
This edition of the Chronicle will be an examination of tariffs, what they are, what they do, and what they may mean for investors. We’ll look to history for examples.
Tariffs are essentially taxes (often called “duties”) on imported goods and are generally used to encourage or safeguard national industries. Tariffs affect not only industries but consumers and foreign affairs. Tariffs can significantly impact U.S. investors in several ways, depending on their nature, scope, and the industries they target. Let’s take a deep dive into tariffs.
What Are Tariffs For?
Governments impose tariffs for a variety of economic, political, and social reasons. While tariffs can provide immediate benefits to certain domestic industries or serve geopolitical goals, they also come with trade-offs, such as higher costs for consumers and potential retaliation from other countries. Here’s a detailed look at why governments impose tariffs.
Tariffs are a simple mechanism. By making foreign goods more expensive, consumers are naturally encouraged to buy domestic goods. This is obviously good for domestic job creation.
The most common rationale for the imposition of tariffs is to protect domestic industries from foreign, often lower-priced, competition. Sometimes, tariffs can shield emerging industries until they are mature enough to go head-to-head with rivals. But established industries, like steel and airplane construction, may need the stabilizing effects and job protection that tariffs can bring.
There is a trade-off, of course: higher costs for consumers may reduce overall economic welfare. Those higher costs don’t have to be from tariffs, of course, as we’ve seen over the recent cycle of high inflation in America.
Replace the Income Tax?
During the campaign, when Trump was asked if tariff revenues would be significant enough to replace income taxes, he replied, “Sure, why not?”
If it seems like a crazy idea to replace the income tax in the U.S. with tariffs, consider that the country was financed largely by tariffs for the first 124 years of its existence. Excise taxes on things like alcohol and tobacco, which are quite similar to tariffs, were also important government funding sources. Amendment Sixteen established individual income taxes in February of 1913.
The Tax Foundation has estimated that a 10% universal tariff would raise $2 trillion, and a 20% tariff would raise $3.3 trillion between 2025 and 2034. Keep in mind that the Congressional Budget Office estimates that the total budget deficit in that period will be $20 trillion.
It seems unlikely that the Sixteenth Amendment will be repealed or that any dramatic changes to the income tax will happen. As a headline figure, it sounds good for the federal government to have additional multi-trillion-dollar funding, but getting the policy right will be a delicate thing.
A Tool of Foreign Policy
Tariffs can be imposed as part of broader sanctions to punish nations for activities such as human rights violations, aggressive behavior, or unfair trade practices.
Tariffs act as carrots and sticks in foreign policy. They can be used as a diplomatic tool to pressure foreign governments to change policies. We have seen the tariffs implemented to change Mexico’s policies on a host of issues, including immigration. And we may see tariffs used against China’s labor policies, particularly with the Uyghur population in Western China.
Tariffs can play a role in national security, protecting vital industries such as steel, energy, or technology. As an example, the U.S. imposed steel and aluminum tariffs in 2018, citing national security concerns under Section 232 of the Trade Expansion Act.
Tariffs can be imposed as a retaliatory measure in response to another country’s unfair trade practices, such as subsidies or dumping. In 2018, the first Trump administration imposed tariffs on Chinese goods in response to allegations of intellectual property theft and unfair subsidies.
Foreign policy works in both directions, of course. Retaliatory tariffs by trading partners can harm domestic industries, notably those same steel, energy, and tech sectors. There is a tension between short and long-term goals. By limiting foreign competition, tariffs can give domestic firms the breathing room to invest in research and development.
Tariffs on high-tech imports might be aimed at fostering innovation in domestic technology sectors. However, they can have the opposite effect: reduced competition may lead to inefficiency and higher costs.
The Boogieman
Tariffs on consumer goods can lead to inflation, reducing the purchasing power of consumers and potentially slowing economic growth. You can ask the Biden/Harris administration about inflation. Or the Carter administration. Inflation is an election winner or loser, depending on which side you’re on.
Of course, inflation doesn’t exist in a vacuum. To combat inflation, the Federal Reserve may increase interest rates, which could hurt bond prices and borrowing costs for businesses and individuals. Some say that it was exactly this combination of prices and economic growth that defined the recent election.
Tariffs can definitely have an impact on the economy. Other countries may impose their own tariffs on U.S. exports, harming sectors like agriculture, energy, and manufacturing.
A decline in global trade can weaken economic growth, creating challenges for companies dependent on international markets.
A Checkered History
Tariff policy is complicated, and it has a checkered history in the United States. Perhaps the most famous example of how tariffs can be harmful to the economy was the Smoot-Hawley Tariff Act of 1930. That act aimed to protect American farmers by increasing tariffs on agricultural imports and on more than 20,000 other imported goods.
Smoot-Hawley tariffs were the second-highest in American history. Average tariffs of 40% to 60% on some 900 goods spurred retaliatory tariffs. One effect was a 65% reduction in global trade. The other was inflation. For a country reeling from high unemployment, this was a terrible double whammy.
Smoot-Hawley highlights how potentially damaging protectionist trade policies are for the U.S. and the world economy. However, we can see how tariff policy, when carefully applied, can achieve a mix of economic, political, and social objectives. Importantly, it’s the credible threats of tariffs that can protect strategic American interests without actually having to impose them.
Tariffs are not as certain as death and taxes, but they have long been a tool of American foreign and economic policy. It seems likely that we’ll be hearing a good deal about them for the next few years. Will they impact the U.S. economy and the retirement security of American families?
As with so many economic and financial influences, we can neither predict the scope nor the impact of new tariffs. It’s key to remember that making those predictions is not only difficult but potentially dangerous if you act on them. Tariffs may or may not be imposed, and if they are, they may or may not impact the stock and bond markets. And that impact may or may not be salutary.
As with all things that cannot be predicted or controlled, we suggest you treat tariffs as more noise in the environment. We live in a messy but marvelously self-correcting society, one that has relentlessly moved forward and made our nation wealthier. We recommend following the example of successful investors: keep calm and compound on.
