Modeling the Impact of President Trump’s Proposed Tariffs

Introduction

Within the first few months of 2018, the Trump administration enacted tariffs on imported solar panels, washing machines, steel, and aluminum. The administration is now considering imposing a 25 percent levy on $150 billion worth of Chinese imports. The proposed Section 301 tariffs are the result of an investigation conducted by the Office of the U.S. Trade Representative (USTR), which found that China engages in unfair trading practices, including the forced transfer of U.S. technology and intellectual property.

Our analysis finds that the $37.5 billion in tariffs would lower GDP and wages by 0.1 percent, lower employment by the equivalent of 79,000 fewer full-time jobs in the long run, and make the U.S. tax burden less progressive.

Tariffs and the Economy

Economists generally agree that free trade increases the level of economic output and income, and conversely, that trade barriers reduce economic output and income.[1] Historical evidence shows that tariffs raise prices and reduce available quantities of goods and services for U.S. businesses and consumers, which results in lower income, reduced employment, and lower economic output.[2]

Tariffs could reduce U.S. output through a few channels. One possibility is that a tariff may be passed on to producers and consumers in the form of higher prices. Tariffs can raise the cost of parts and materials, which would raise the price of goods using those inputs and reduce private sector output. This would result in lower incomes for both owners of capital and workers. Similarly, higher consumer prices due to tariffs would reduce the after-tax value of both labor and capital income. Because these higher prices would reduce the return to labor and capital, they would incentivize Americans to work and invest less, leading to lower output.

Alternatively, the U.S. dollar may appreciate in response to tariffs, offsetting the potential price increase on U.S. consumers. However, the more valuable dollar would make it more difficult for exporters to sell their goods on the global market, resulting in lower revenues for exporters. This would also result in lower U.S. output and incomes for both workers and owners of capital, reducing incentives for work and investment, and leading to a smaller economy.

Results

According to the Tax Foundation Taxes and Growth model, President Trump’s proposal to raise tariffs by about $37.5 billion annually would reduce the long-run level of GDP by 0.1 percent, or about $20 billion. The smaller economy would result in 0.1 percent lower wages and 79,000 fewer full-time equivalent jobs.

On a static basis, the new tariffs would reduce after-tax incomes for all taxpayers by 0.24 percent. The increase in tariffs would make the distribution of the tax burden less progressive. These tariffs would reduce after-tax incomes for taxpayers in the bottom 80 percent by 0.25 percent and by 0.23 percent for the top 20 percent. The top 1 percent of taxpayers would see the smallest reduction in after-tax income, at 0.2 percent. On a dynamic basis, after-tax incomes would be slightly lower due to lower economic output, which would result in a further lowering of incomes.

Conclusion

President Trump has proposed tariffs on $150 billion of goods. These tariffs would result in GDP and wages falling by 0.1 percent in the long run, and 79,000 fewer full-time jobs. The tariffs would fall more on middle- and lower-income taxpayers, making the distribution of the tax burden less progressive.

Modeling Notes

The Tax Foundation modeled the impact of tariffs with the Taxes and Growth model.[3] In the Tax Foundation’s model, tariffs are treated as a targeted excise tax on the tradeable sector, which ultimately fall on U.S. labor or capital and result in lower output. To model the distributional impact, we passed the tax backwards as reductions in factor income, which reduced the returns to both labor and capital income. In modeling the tariffs, we did not account for the potential reaction of foreign countries, nor the additional losses in welfare from having taxes with uneven impacts across sectors, both of which could result in additional economic effects.

[1] L. Alan Winters, “Trade Liberalisation and Economic Performance: An Overview,” The Economic Journal 114:493 (February 2004).

[2] Erica York, “Lessons from 2002 Bush Steel Tariffs,” Tax Foundation, March 12, 2008, https://taxfoundation.org/lessons-2002-bush-steel-tariffs/.

[3] Tax Foundation, “The Tax Foundation’s Taxes and Growth Model,” April 11, 2018, https://taxfoundation.org/overview-tax-foundations-taxes-growth-model/.