One of the recent big talking points to come out of this presidential election is the idea of tariffs. As recently as Friday, former president Trump talked about the idea of eliminating income taxes and replacing it with tariffs. Sounds good right? Sure, if you don’t know how tariffs work. Donald Trump himself either doesn’t know how they work, or knows the bulk of the voting public doesn’t and won’t bother to find out. I’m not an economist, but I do have a business degree and scored well in micro and macroeconomics. If all you know about tariffs is what you’ve heard from Trump or conservative media outlets, please take a few minutes and read this post. I think it’s important to understand what is being proposed, and what the potential benefits and pitfalls are. I’m going to be as non-biased as possible.
What is a tariff?
From Principles of Economics 3e: tariffs are taxes that governments place on imported goods.
Make sure you read that slowly, word-for-word.
Donald Trump is selling them as taxes placed on foreign governments for exporting goods. No foreign government is paying a US tariff.
Can I get an example?
Sure. Henry’s Hat Hut has found a hat maker in China to purchase custom hats that they will sell in their small Main Street shop. They negotiate a price of $10 per hat, and order 100. The total price is $1,000 and the hats go into production. They plan to sell the hats in their store for $12 each, so they would make $2 off of each one sold. When they go to pick up the package from the closest Port of Entry, they are hit with a $100 charge to cover a 10% tariff that the US Government placed on imported Chinese hats, and that tariff must be paid before receiving the goods. Their cost just increased $1 per unit. Now, Henry’s Hat Hut has decided to increase the selling price to $13 per hat to cover the tariff and still make $2 on each hat sold.
That’s a hypothetical scenario, but that’s basically how it works. China doesn’t pay that 10%. The Chinese manufacturer isn’t responsible for paying that 10%. Somebody in the United States is paying the 10%, and it almost always ends up being the consumer.
Why are tariffs good?
Tariffs keep American manufacturers competitive within the global market. Many other countries can often produce a comparable product at a lower cost due to cheaper wages, an efficient supply chain, efficient logistics, and so forth. Placing a tariff on these lower cost imported goods brings their market price closer to the cost of the comparable product manufactured in America.
Why are tariffs bad?
It increases the cost of products for consumers. Here’s a hypothetical scenario: I just bought a set of 4 new tires for my car 6-months ago. I had to choose between the $120 Goodyear tires that are made in America, or the store-brand, Chinese manufactured tires for $100. I only had $400 budgeted, so I purchased the store-brand. Today, I hit a piece of metal that was in the road and sliced one of my 6-month old tires beyond repair. Thankfully I have exactly $100 left in my bank account until the next payday, so I can afford to have it replaced. The problem is, I didn’t realize that the United States just placed a 20% tariff on imported Chinese tires last month. The good news is, I can get the American made tire for the same price as the Chinese made tire. The bad news is, now I can’t afford either. It’s almost like fabricated inflation or foreign-made goods.
Didn’t tariffs largely fund the government before the federal income tax began in 1913?
Yup, they sure did.
Can’t we just go back to that and eliminate income tax like Trump is suggesting?
That actually would be nice, but the answer is: not a chance in Hell.
This explanation can get really really complicated with a ton of variables, but I’m going to simplify it the best I can. The United States has largely gotten out of the manufacturing game. According the National Association of Manufacturers, manufacturers accounted for 10.70% of the total output in the country and employed 8.41% of the workforce. The United States had a trade deficit of $773.4 billion in 2023, meaning we imported that much more than we exported. The last time we operated at a trade surplus 1975. Our highest trade surpluses were back in the early 1900’s when we had high tariffs.
You may think that we can just impose high tariffs and cut income taxes and break even. Remember, the United States doesn’t manufacture nearly as many products as it once did. Yes, significantly raising tariffs may promote the regeneration of American manufacturing, but its us the consumers that will pay the price in the meantime. Most companies aren’t going to move manufacturing back to the United States unless the market requires it. It’s insanely expensive to start a manufacturing operation in this country, so in order for companies to do that, it has to be the only option. It becomes the only option by having their income collapse. It collapses because American’s can’t afford what they’re producing and importing for sale due to the newly applied high tariffs. Best case scenario, they decide to start manufacturing in the United States. Worst case scenario, they stop doing business here.
That’s the worst case scenario because now you run into issues with scarcity. Let’s use Trump’s 200% tariff that he’s talked about applying at various times. Your $10 Walmart tshirt that’s made in China now costs $30. “Well hell, I can get a made in the USA T-shirt for only $20, I’m going to buy that instead.” So is everybody else. Suddenly, everybody is rushing to buy the Made in the USA shirt at that price. Great, right? Wrong. The company that was selling the $10 shirts to Walmart knows they can’t compete on price anymore and can’t afford to start a clothing factory in the United States, so they make the decision to liquidate and go out of business. The American shirt company doesn’t have the capacity to increase production, and they’re not going to be able to keep up with that sudden massive increase in demand. When demand goes down, supply goes up, and prices drop. When demand goes up, supply goes down, and prices increase. That’s the basics of Supply and Demand. The American company now has no competition since the company selling the Chinese made shirts went out of business. Now capitalism takes over. They start using cheaper materials to increase profit margins. They increase prices to make sure there are shirts on the shelves to purchase. Suddenly, you go from having the choice of buying a cheap $10 shirt or a higher-quality $20 shirt, to now only having a cheaply made shirt available for $30.
Folks, if you think post-COVID inflation was bad, buckle up if this plan goes into effect, because the dollar will quickly become the quarter.
We just don’t have the manufacturing capacity to put this into place. Even if we started building all the required manufacturing facilities today, a small percentage of them would be producing maximum output by the end of the next President’s term. It’s expensive, there’s a shit ton of red tape from all levels of government, and we don’t have the infrastructure in place to support it. Not to mention, where are we going to find the millions of people that would be needed to take these manufacturing jobs? I mean, we could employ all the non-citizens that are coming here and looking for work, but Trump is going to deport all of them, so there goes that option. If you remember, the price of produce and other foods went up when many food and farm industries lost a lot of their workforce when he implemented ICE crackdowns. Locals might remember the empty crab-picking houses when the Trump administration changed the H-2B visa program for seasonal workers.
I’d love to not have to pay income taxes, and Trump has done a great job of selling that possibility, but he’s intentionally not telling you the whole story. At least I hope he’s doing it intentionally. I would hate to think that a self-proclaimed “great businessman” doesn’t know how tariffs work, especially since it’s usually taught in the first month of a Business 101 course. What Donald Trump is proposing is not possible, or at least it’s not possible without sending this country into a 2nd Great Depression and causing record inflation “like the world has never seen,” as he would say.
I really hope this makes sense. Like I said in my last post, vote for who you want, but make sure you are being skeptical, and become knowledgeable on what and who you’re voting for….. and hoping for. I don’t want you don’t regret your decision.
Thanks for reading.
-T