Last week, a number of economists, including me, circulated a statement in favor of free trade and against tariffs. Although the statement is lengthy, it can’t address all the issues. Here I lay out in more detail why proponents’ case for tariffs is typically faulty, and what might be a sound case for tariffs.
Confusion over deficits
Proponents of tariffs often argue that tariffs are justified by the fact that we Americans have ongoing trade deficits with the rest of the world. Sometimes they even focus on specific countries, such as China and Mexico, with which we run trade deficits. They believe that imposing higher tariffs on the rest of the world and on the specific countries with which we have high trade deficits will reduce those deficits.
Let’s consider the argument step by step. First, is a trade deficit with a particular country bad? No. One of the easiest ways to see that is to look at your own spending on other producers’ goods. Consider mine. Our household spends over $5,000 a year on groceries from Safeway. But those scoundrels at Safeway spend nothing on my output. If you’re employed, your employer has a trade surplus with you. He or she spends much more on your services than you spend on his products. But that’s not a problem.
The same reasoning applies to a specific country. Our trade deficit with Canada in 2024 was about $36 billion, not the $100 billion that President Trump seems to have pulled out of thin air. And contrary to Trump’s belief, the fact that we spend more on imports from Canada than Canadians spend on our exports does not mean that we’re subsidizing Canadians, any more than I’m subsidizing Safeway. There’s no reason that we should have a zero trade deficit with a particular country. In 2024, the United States had trade surpluses with the Netherlands ($56 billion), Hong Kong ($22 billion), Australia ($18 billion), and the United Kingdom ($12 billion). Was that a problem for those countries? The heads of those countries and, apparently, many of their citizens, don’t seem to think so. It’s very much like you having a trade surplus with your employer.
How about the fact that the United States has an overall trade deficit with the rest of the world in general? In 2024, we exported $3.19 trillion in goods and services and imported $4.11 trillion in goods and services, for an overall trade deficit of $0.92 trillion. What happened to that $0.92 trillion? Did people in other countries keep those dollars? It would have been great if they had. Our government spends less than 10 cents printing a Benjamin. And in return for each $100 we got $100 in goods and services. I’ll take that deal any day. Actually, though, the vast majority of the money came back to the United States in the form of investment. Foreigners used it to buy US government bonds, to buy land and plant and equipment, and to invest directly. The United States, for all its problems, is still seen by much of the world as a haven for investors. Note the irony. On the one hand, Trump is happy that many foreigners are investing in the United States. On the other hand, he’s upset that we have such a large trade deficit. Mathematics is not optional: the trade deficit and the capital surplus are the mirror images of each other.
Would higher tariffs on countries with which we have a trade deficit reduce that trade deficit? There’s no good reason to think so. If our government imposes tariffs on imports from countries with which we have a large trade deficit, we will buy fewer imports from people in those countries. They will then have fewer dollars to buy our exports. Moreover, some of those countries will retaliate with their own tariffs on our exports.
Why the capital surplus, and should we worry?
There is one other main reason, besides the fact we are a haven, that we have a capital surplus with the rest of the world: our high federal budget deficit attracts foreign buyers of government bonds. But the best way to address the federal budget deficit is to reduce the federal budget deficit. And the best way to reduce it is to reduce federal government spending. In its March 2025 report on the budget outlook, the Congressional Budget Office estimates that federal spending will be 23.3 percent of GDP this year, which is over 2 percentage points more than its 21.1 percent average for the previous twenty years.
Should we worry? Yes and no. We should worry about the huge federal budget deficits and the federal debt that is growing as a percentage of GDP. The CBO estimates that by 2055, the federal debt held by the public will be 155 percent of GDP, up from its current already scary 100 percent.
But no, we shouldn’t worry about a capital surplus per se. One reason I often hear people give for worrying is that at some point in the future our country will be largely owned by foreigners, and we will have little. The historical record refutes that fear. We have had annual trade deficits every year since 1976. That’s almost half a century. Yet over that time, the average net worth of a US household rose from $364,893 in 1975 to $1,212,974 in the fourth quarter of 2024, all in 2024 dollars. You might think that average household net worth can’t be that high. But remember that it’s the average and the average is skewed by a few million households with multimillion-dollar net worths. You might also think that that’s irrelevant to many of us, but it’s relevant for purposes of addressing this issue. Remember that the issue is whether foreigners will largely own our assets because of those persistent trade deficits. The data above show that they aren’t close. If something you’re worried about hasn’t happened even though the data underlying the worry have existed for half a century, maybe you shouldn’t worry so much.
Who pays tariffs?
Nicholas Gilbert, a dairy farmer in upstate New York, recently expressed outrage when he had to pay a $2,200 tariff on feed he got from Canada. I would be upset too. The unusual aspect of this story, though, is that he wasn’t upset at Donald Trump, the person who imposed the tariff. No. He was angry at Canadians for charging him more. A strong Trump supporter, Gilbert was gullible.
An article in the Atlantic quoted Gilbert:
I’m not even sure it’s legal! We contracted for the price on delivery. If your price of fuel goes up or your truck breaks down, that’s not my problem! That’s what the contract’s for.
From all appearances, though, the Canadian exporter kept his side of the bargain. What Gilbert learned the hard way is that tariffs are taxes on imports, not on exports. They are always paid explicitly by the importer.
That doesn't mean that importers bear the whole burden of a tariff. If people in a country import a large enough percent of another country’s exports, tariffs can drive down the export price somewhat. But various economists who have examined the tariffs that Trump imposed in his first term have found that the importers bore virtually all of the burden.
What to do if other countries keep tariffs high
On April 2, in a Rose Garden speech, President Trump finally unveiled his plan to impose “reciprocal tariffs” on imports from other countries.
The chart he presented, though, was not based on the tariffs those countries were charging. Instead, it was based on an equation that nowhere included the tariff rates charged by governments of other countries. While Trump listed all the countries he wanted to impose higher tariffs on, he neglected to mention that the tariff rates charged by forty-four countries are lower than the average that the United States imposed before Trump’s increases. Most of these countries, admittedly, are small, but they include Canada, France, Germany, Italy, and Japan. Trump did not announce a cut in tariff rates to these countries, thus putting the lie to his claim that he wanted reciprocal tariffs.
But put all that aside. Imagine, contrary to the data, that every country’s government in the world imposes higher tariffs on our exports than the US government imposes on our imports. What would be the best strategy for our government?
The answer may shock you, but I assure you that my answer is based on decades, nay centuries, of economic reasoning and evidence. The answer is: cut our tariffs to zero.
Why? It’s true that when a foreign government imposes tariffs on our exports, it hurts our producers. It also hurts the foreign government’s consumers. If our government responds by imposing tariffs on imports from that country, it helps our producers who compete with those products but hurts our buyers of those items. Those buyers include not just ultimate consumers, but also producers who use the tariffed items as inputs. It’s relatively easy to show, although you need a graph of supply and demand, that the losses to our consumers exceed the gains to our producers.
The bottom line, therefore, is that whatever the other country’s government does, our government’s best option, if it puts the same weight on losses to consumers as it puts on gains to producers, is to have zero tariffs.
Two major figures in the last century used metaphors to make the point. One was President Reagan. In the early 1980s, he argued that if you’re in a lifeboat and someone shoots a hole in the boat, it’s not a good idea to shoot another hole in the boat. Yes, you’ll hurt the first shooter; but you’ll also hurt yourself.
The other was famous British economist Joan Robinson. If someone in another country to which you ship goods puts rocks in the harbor to make shipping more difficult, she asked, does it make sense for you to put rocks in your harbor?
The two plausible arguments for tariffs
I’ve dealt with the bad arguments for tariffs. Are there more sensible arguments for tariffs? There are two main ones.
The first is for national security. We might buy inputs from countries whose governments we think will be hostile to us. If they become hostile, they might refuse to sell us those inputs. Exhibit A for many people nowadays is China. Tariffs in such cases might make sense if they lead to domestic production, admittedly more expensive, to replace the cheaper imports. But tariffs are not typically what economists call “first-best solutions” to the national security problem. A better way is to have the government stockpile the input. But that solution, just as with tariffs, depends on government doing a good job.
Unfortunately, government officials don’t have good incentives to do a good job. I lay out in “Does National Security Justify Trade Restrictions?” (Defining Ideas, December 5, 2024), how bad a job government did stockpiling rubber in the months leading up to US participation in World War II.
While we’re on the issue of national security, don’t forget that one major factor that makes us secure is a strong economy. All else equal, zero tariffs make our economy stronger than otherwise.
Tariffs within an overall tax system
One other intellectually respectable argument for tariffs is that they are part of an optimal tax structure. Our federal government taxes many things: individual and corporate income, capital gains, commodities like gasoline, etc. How can we be sure that a positive tax rate on imports is not part of an optimal tax system? We can’t. We do know that the deadweight loss, which is the overall loss from the tax minus the gain to the government, is proportional to the square of the tax rate. For example, doubling a tax rate quadruples the deadweight loss. So, it could be true that reducing the top marginal tax rate on income from its current 37 percent to, say, 35 percent, and replacing it with a 5 percent tax on imports could reduce overall deadweight loss.
Surprisingly, I have not seen any of Trump’s economists make this case. Maybe that’s because to do so would be to admit that tariffs are taxes and that taxes impose costs on those who are taxed. Is it just possible that Trump wants his supporters to be as ignorant of the cost of tariffs as the MAGA dairy farmer in upstate New York was?
