Trump's Import Taxes Could Devastate US Economy

Daniel J. Ikenson

Give President-elect Trump credit for consistency. In his selections of Wilbur Ross as commerce secretary, Peter Navarro as chairman of the National Trade Council, and Robert Lighthizer as U.S. trade representative, Trump has empowered a protectionist triumvirate to deliver on his provocative campaign promises.

Among the various ahistorical ideas under consideration is an across-the-board tariff of 10 percent on all imports. Exactly what the intended purpose of such a tax would be remains unclear — To achieve trade balance by reducing imports? To dissuade U.S. companies from outsourcing? To encourage foreign companies to invest in the United States? To show the world who’s boss?

Insanity may be too mild a diagnosis.

First of all, as numerous analyses from the Cato Institute have gone into great detail to demonstrate, the U.S. trade deficit is not a problem to fix. It is a reflection of the relative faith that foreigners have in the U.S. economy as a safe and potentially lucrative destination for their savings.

Even though some people are confused by the meaning of the trade deficit, in reality it is a benign statistic — a reflection of many things, but absolutely not the success or failure of trade policy.

In any event, a 10 percent tariff on imports would certainly have the effect of reducing imports. But, with fewer dollars in foreigners’ pockets and retaliatory measures at hand, U.S. exports would decline as well.

The tariff would have a negative impact on overall trade, but no predictable impact on the trade deficit.

The tariff would be akin to a 10 percent tax added to the bill at Walmart.

Second, the notion that a duty would dissuade U.S. companies, in the aggregate, from investing in production or assembly operations abroad is also absurd. In order to compete both at home and abroad, U.S.-based producers need access to competitively priced inputs.

Tariffs raise the cost of production for companies operating within the tariff walls, bestowing relative cost advantages on foreign firms and U.S. operations abroad, while retarding investment in value-added domestic activity.

Third, a tariff would, on net, do nothing to encourage foreign companies to invest in the United States. Investment flows to locations with low trade barriers, where the political and business climates are stable, where respect for the rule of law is secure, and where crony capitalism is sufficiently suppressed.

Sure, some foreign firms might decide it makes sense, given their cost structures, to produce inside the tariff walls (that induced Honda to build its first U.S. plant in 1982), but, on net, it will drive companies away because the nature of production is global.

The proliferation of cross-border investment and transnational supply chains has blurred the distinctions between U.S. and foreign products and has rendered tariffs on imported inputs incompatible with the imperative of wooing, securing and maintaining productive, capital investment in the United States.

The factory floor spans oceans and borders and cannot function efficiently with tariff walls between its operations. It turns out that showing the world who’s boss is the most plausible motive behind the 10 percent tariff, but it’s a deeply misinformed motive.

The average U.S. tariff currently stands at about 2 percent, so adding to that another 10 percentage points would render many production operation unviable. Maybe Team Trump is unaware that raw materials, intermediate inputs, and capital equipment accounted for half of the $2.2 trillion of U.S goods imports in 2015.

Nearly all of that $1.1 trillion of mechanical parts, electronic components, steel, chemicals, minerals, stamping machines, and the like went into production operations at U.S. factories, utilities, construction sites, and mines, supporting millions of U.S. jobs.

That $1.1 trillion registers on the income statements of U.S. businesses as a cost of production. A 10 percent tariff would add $110 billion of costs to their books.

Well, couldn’t that loss of profit be made up by generating more revenues abroad? Unlikely. In fact, businesses should expect to see their export revenues decline, as foreign governments around the world respond to Trump’s aggression by imposing tariffs of their own.

In 2015, U.S. exporters sold $1.5 trillion of goods to foreign buyers. If a 10 percent tariff imposed on U.S. exports reduced U.S. business revenues by, roughly, $150 billion, the combined impact of cost increases and revenue decreases would be a profit reduction of $260 billion for U.S. goods producers.

To put that in perspective, in 2015, the U.S. manufacturing sector registered profits of $511 billion. So, without even considering the impact on households, producers alone could expect to see their profits cut in half.

Of course, that would lead to lower levels of investment, reduced output, and employment contraction.

But the pain wouldn’t stop there. Many of the same people who lose their jobs would see their living costs rise, as the 10 percent tariff would also apply to the $1.1 trillion of imported consumer goods.

Tariffs are very regressive taxes — they disproportionately affect people on the lower ends of the income spectrum. Lower income families spend higher proportions of their budgets on goods than on services, and many of those goods are imported — clothing, shoes, food, etc.,.

The tariff would be akin to a 10 percent tax added to the bill at Walmart.

With little evidence that Congress or respect for the Constitution will impede the new administration’s determination to fix what isn’t broken, the best to hope for is that the economic damage is not cataclysmic, but is painful enough that we as a nation can finally agree to bury the doctrine of protectionist nationalism once and for all.

Dan Ikenson is director of the Cato Institute’s Herbert A. Stiefel Center for Trade Policy Studies.