A Laffer curve for tariffs

A Laffer curve for tariffs

There a Laffer curve for tariffs. You may recall that the Laffer curve shows that at some point, raising taxes results in less tax revenue. This is also true for tariffs. If you raised tariffs to 100 percent you would get less tariff revenue than at 10 percent because of less trade. That is why the logic of punitive taxes escapes me. When Trump lashes out at a country and increases tariffs that means only fewer and higher priced goods to Americans. Why is dramatically raising taxes punishing those that dare incur Trump’s wrath especially if they are just motivated to find trading partners elsewhere? Instead the tariffs are punishing Americans.

Trump wants us to import less. Well he is succeeding. But will importing less goods make us better off? That is virtually impossible as consumer prices go up and real incomes go down. Prices go up because there are fewer less costly goods available – that is what comparative advantage is all about. Domestic producers of competing goods find demand (and prices) rise for their goods. They have less competition and hence have less incentive to innovate and economize.  The tariffs have a disproportionate impact on small businesses and on low and moderate income households. Let them eat cake!

Tariffs will not bring in the revenue that Trump trumpets. To do so would assume that as prices increase due to the tariffs that demand stays unchanged. Instead as prices increase – and we pay 96% of the increase – imports fall decreasing tariff revenues. Raising tariffs even more would decrease – not increase – revenues. So if raising revenues is a motive for tariffs, it is a failed one. So tariffs will not make us rich as hell. It cannot replace the income tax. There is not enough to give everyone $2,000. It won’t get rid of trade deficits – if he wanted to do that then he should simply ban all imports. It was never “reciprocal” because it was levied on countries with tariffs lower than our and on countries with which we had a surplus. Foreigners do not pay the tariffs, we do – whether at the consumer level or the importer level. Trump’s tariffs have had the equivalency of a 16 percent tax hike. Foreign central banks have been replacing dollar and Treasury holdings with gold. Foreigners have been restructuring their supply chains and making other trade agreements. Trump has brought the world closer together and has made China’s trade surplus bigger than ever, having topped $1 trillion as the Chinese have broadened their trading worldwide. Why would Trump want to help the Chinese and hurt Americans is beyond me.

If tariffs were to rebuild American manufacturing then why has manufacturing fallen over the past year? Trump seems to forget that half of our imports are intermediate goods. Thanks to the president we are now facing record high prices on aluminum. Industries such as automotive, aerospace, packaging and construction have seen dramatic increases in their costs, lower margins, profit squeeze and a struggle to survive. Small businesses have been particularly affected. Trump doubled tariffs on U.S. aluminum imports to 50% and aluminum costs for U.S. consumers have risen by 40% to above $5,200 a metric ton. The tariffs resulting in a drop in imports which reduced aluminum stocks, increasing prices even more. Foreign producers sent their aluminum elsewhere. Also the high tariff meant that importers were actually losing money on importing aluminum and ratcheted down their purchases further reducing US stocks and increasing US prices. In the national security argument why impose tariffs on aluminum (or steel) if it is vital to national security? Wouldn’t it more sense to impose no tariffs on imported aluminum while subsidizing the domestic aluminum industry?

Isn’t it ironic that Trump wants to rebuild American manufacturing while he has actually instituted policies that have done the opposite? Don Boudreaux points out that US manufacturing has declined under Trump’s protectionist policies. I cannot think of hardly any circumstance where I would support tariffs because almost without fail they increase the prices to American consumers and make us worse off. US manufacturers facing less competition become less efficient. 

What about the argument that the Chinese heavily subsidize their export industries so that they can price in local markets at below cost leading to unfair prices competition? This means that the Chinese government bears the cost of below market pricing and causes the Chinese to be worse off while making the rest of the world better off. It is no wonder that the Chinese economy is actually in trouble with heavily subsidized export industries producing at excess capacity. Huge trade surpluses are symptomatic of declining investments – especially foreign investment. Business investment in China’s private economy fell 6.9 percent last year. Retail sales depend on subsidies as well also leading to overproduction and more losses. Then there is the property bubble. High levels of debt exist at the national and local levels. Overcapacity is leading to price deflation at home and in the export sector. China may be exporting more but at losses that are not sustainable. And Trump wants us to be an export economy?

There a Laffer curve for tariffs. As Trump’s tariffs increase, we become worse off. Also his threats are running into diminishing returns. Not only will tariff revenue fall as imports drop, countries will find other trading partners if it is rational to do so. I know that the president frets about slow economic growth and blames the Fed. But what would happen if suddenly he completely lifted all of his tariffs? Can you imagine the impact on growth if all of a sudden there was a universal tariff of zero?