The Wall Street Journal characterized the Trump tariffs on Canada and Mexico this way:
That’s a bit harsh, isn’t it?
In this post, I’m going to explain what the WSJ and more-or-less all other professional economists are getting wrong about this issue.
This one trick insight changes everything.
The WSJ editorial page may have been a bit blunter than some. But it’s a fair reflection of informed opinion on this topic. It’s almost no exaggeration to say that everyone with any professional interest in economics, international trade, or foreign affairs has been baffled by the reasoning behind the Trump tariff proposals.
But maybe, just maybe, these tariffs are not as irrational as they have been made out to be.
I believe that all the professionals in international trade misunderstand the simple policy logic that drives us inevitably to these tariffs.
I claim that the fundamental error that professional pundits are making is in thinking that these tariff have anything whatsoever to do with U.S. international trade policy.
The inescapable logic of the Trump tariffs.
Viewed as trade policy, these tariffs are every bit as dumb as the WSJ said. But viewed from a different perspective, they make absolutely perfect sense. And that’s because these tariffs aren’t Federal trade policy, they are Federal income tax policy.
Huh?
The income tax cuts from the first Trump administration are set to expire. Depending on who’s doing the estimate, those tax cuts cost the Treasury $300B to $400B a year. Ish.
To get them extended, without increasing the deficit, you need to find at least $300B a year to make up the loss.
And, to increase the difficulty factor, you’re a Republican, so raising a tax on anything is out of the question.
What’s the easy, no-effort way to achieve that goal of finding $300B a year, without increasing Federal tax revenues?
First, you must adamantly insist that tariffs are not taxes, and that Americans don’t pay for import tariffs. No matter how stupid everyone who knows anything about anything says that assertion is. You must insist that tariffs are not taxes, because you, as a modern Republican, are not allowed to raise taxes.
Next, you sort your trade partners, from high to low, in terms of dollar value of imports. Pick a good round number like 25%. And go down the list until 25% of the value of imports exceeds $300B.
Even though, again, anyone who knows anything about trade policy will tell you that makes no sense. I mean, you haven’t even focused on the countries where we have the biggest trade deficit. You haven’t (say) accounted for strategic materials, or domestic industries that depend on imported parts, or your own vulnerability to retaliatory tariffs.
Instead, you’ve sorted our trading partners by descending order of value of imports (only).
That’s literally as deep as the thinking goes. Because that’s as deep as it needs to go, to achieve the goal. Which, recall, is domestic income tax policy, not international trade. And that’s because the value of imports (less reduction in demand, when the tariffs are imposed) is what determines your revenue.
Now see how far down the list you need to go, before you get your $300B a year.
Answer: Canada, Mexico, and China.
And suddenly, the entire two-part “policy” snaps into focus.
These tariffs have nothing to do with trade policy, America’s position in the world, or anything else that a reasonable person might consider.
Instead, look at what this policy consists of:
Part 1: You must keep insisting that tariffs are not taxes, because you are not allowed to use the t-word, as a Republican. This part of the policy is required, because the goal is to raise Federal revenues significantly without saying the t-word (taxes). So everybody has to agree that tariffs are not taxes, and that Americans do not pay their cost. Even though everybody who knows anything about international trade will tell you that’s incorrect.
Part 2: Target countries not in terms of our trade deficit with them, or other practical considerations like impact on U.S. industry, but solely in terms of the value of what we import from them. And that, too, makes sense, because import volume is what determines your tariff revenue, less the reduction in demand that will occur once prices rise in response to the tariff).
Why is it now 25% each for Mexico and Canada, and 10% for China? My guess is, that’s because that’s when they hit the required projection of tariff revenues that they need. Why are we now talking about tariffs on everything, from all countries, characterized now as “reciprocal tariffs”? Best guess, the revenue target has changed, or the estimated revenues from the existing tariffs have changed.
Conclusion
Sometimes it’s difficult for really bright people to understand how not-so-bright people think. Or for those with expert knowledge to understand the rank amateur.
If the Trump tariffs appear divorced from any rational thinking about international trade, that’s because they are.
But from the Trump administration standpoint, that’s not a bug, that’s a feature. That doesn’t mean that they were done at random, or that they were otherwise harmless. Merely that trade policy was not the point.
Instead, import tariffs are simply a) a potentially large source of revenue that b) you can claim is not a tax. From that perspective, this two-part policy makes perfectly good logic. If not much sense.
It’s only a bit of a poetic justice that you get to keep your tax cuts largely favoring the wealthy, by substituting tariffs whose burden falls disproportionately on the poor (for the simple reason that the rich have a high rate of savings.)
Thus, the secret to understanding the logic of the Trump tariffs is that trade policy is just an innocent bystander. If what you really care about is extending tax cuts, then, eh, if your solution messes up North American manufacturing for the next decade or so, so be it.
Republicans have agreed to hold hands, close their eyes, and claim that import tariffs are not taxes on Americans. And ignore how badly this screws up big chunks of U.S. manufacturing, starting with automobiles.
And, ka-ching, there’s the free $300B in revenue you need to extend the existing tax cuts.
Which is what really matters.
Wonky addendum:
Note, by the way, that if this goes through — if those tariffs are counted as revenue, against the Treasury’s losses from the tax cuts, then …
… well, back in the day, when rules still existed in the Federal government, then those tariffs would be permanent. Or, at least, as permanent as the tax cuts that they funded.
(This, from PAYGO, originally developed around 1990, and, as of 2019, fully in force in both the House and the Senate. Any legislation passed by the Congress had to be paid for by a combination of tax increases and spending cuts, unless an exception is made, by a supermajority vote. Here’s a rather complicated explanation from Wikipedia.)
I’m not sure how this would work, under PAYGO, as the tariffs are not based on legislation. But I would bet that there’s a way for Republicans to claim the money, as they extend the Trump tax cuts.
So, to be clear, this is once again completely unlike normal tariff policy. If these are put into place, and Republicans (at least mentally) count the revenue against the losses from the tax cuts, then these tariffs must be, for all intents and purposes, permanent.
Luckily (?), there appear to be no rules whatsoever governing the Federal government now. So we don’t have to worry about these becoming permanent.
