On My Mind: T-Day

US President Donald Trump’s “Liberation Day” announcement is a step toward some greater clarity on tariff policy, after months of disruptive uncertainty. The announcement sets the stage for potential bilateral negotiations, so the uncertainty is not over, but it has at least put the worst-case scenario on the table.

We could more properly call it T-Day, for “Tariff Day.” The highlights: an average additional 34% tariff on Chinese imports (bringing the total tariff to 54%); 20% on imports from the European Union; for Canada and Mexico, United States-Mexico-Canada Agreement (USMCA) goods remain exempt, while the remainder will be subject to duties; tariffs on other countries will vary, but with a minimum of 10%. And there will be an across-the-board 25% tariff on cars.

The uncertainty we have faced so far has caused companies to put investment plans on hold, and has held back growth in the first quarter of the year. The emerging clarity should gradually allow businesses to start reformulating their plans. However, uncertainty remains significant, especially as concerns potential retaliations that might spill over into a broader trade war.

I thought it would nonetheless be useful to get a sense of the impact of these tariffs, starting with a few simple back-of-the-envelope calculations.

The Trump administration expects the new tariffs to raise about US$600 billion per year. Some are skeptical that this target can be achieved, so let’s take that as a ceiling and also consider an alternative scenario with a lower intake of US$400 billion.

Tariffs are a tax; they increase government revenue, but, like all taxes, they have an adverse impact on growth. They are a tax on consumption, specifically on the consumption of imports. How big of a tax increase are we looking at here? Based on 2024 national accounts figures (Source: Bureau of Economic Analysis), US gross domestic product (GDP) amounted to US$29 trillion. Consumption accounted for almost 70% of it, or close to US$20 trillion.

The expected US$400 billion-US$600 billion in revenue, therefore, would be equivalent to a 2%-3% tax on total consumption of goods and services. It would also correspond to a 12%-18% average tariff on all imports of goods (as 2024 goods imports amounted to about US$3.3 trillion). The numbers are summarized in the table below. As I have noted in past articles, imports are a very small share of US GDP; therefore large tariff rates hit only a small share of overall US consumption, and are equivalent to fairly low overall sales tax rates.

Suppose that the government had announced a 2%-3% across-the-board sales tax. I think the reaction among analysts and the market would be perhaps less panicked than some of the headlines we see. There would be some concern about the negative growth impact, but few would predict a recession, and I don’t think anyone would question the idea that the bump to inflation would be temporary. We have estimated that the temporary impact of these tariffs on inflation would be in the region of 1.25-1.50 percentage points (pp).

Who will ultimately bear the burden of this tariff tax, US consumers, or foreign producers? Tariffs are always paid by the importer. The United States, however, has substantial bargaining power. The US consumer has always been regarded as the main engine of global growth, and for many foreign countries the United States is a key export market. Foreign producers should therefore be willing to absorb some of the tariff by compressing their profit margins to maintain market share. After all, many companies have been willing to see their intellectual property “taxed” away by Chinese competitors to access the large China market. But if competition is working, the scope for profit margin compression should be limited, so US consumers will pay the largest share of the added tax burden.

A 2%-3% sales tax would raise few eyebrows. Most economists and public finance experts agree that a consumption tax is the most efficient way to collect significant amounts of revenue—preferable to either income taxes or taxes on capital. This is why European countries with government expenditure ratios in the range of 45%-50% of GDP rely on Value Added Taxes (VAT). 

Import duties, however, are an inefficient way of taxing consumption. By taxing some goods but not others, they distort consumption decisions. And by imposing an additional burden on foreign producers, they reduce competition. Domestic US producers will have less of an incentive to increase productivity. The result would likely be slower productivity growth and somewhat higher underlying inflation pressures in the goods sector.

Like any tax, tariffs need to be assessed in the context of overall fiscal policy. Trump indicated that the focus will now shift toward tax and spending cuts. Incremental reductions in personal and corporate income taxes would mitigate the adverse impact of tariffs on growth. But there is a trade-off here: Larger income tax cuts would also offset some of the revenue impact of tariffs. To put the budget deficits on a more sustainable path, I continue to believe that the United States needs significant reductions in expenditures, well beyond what the department of government efficiency can realistically achieve.

Over time, in theory, import tariffs might lead some companies to relocate production to the United States. However, the extent and speed at which this happens will also depend on other factors including regulations, the stability and predictability of the overall macro environment, the quality of infrastructure, energy costs, and the availability of workers with the necessary skills. Relocation of production will take time, in many cases, at least a 3–5-year horizon.

Tariffs are certainly not my preferred policy instrument. My back-of-the envelope numbers suggest that the impact on US growth and inflation should be manageable. There is still significant uncertainty on the potential global repercussions, however. First of all, the growth impact will be much more significant on foreign countries that rely more heavily on exports as engines of growth. Secondly, trade redirection might trigger broader tariff increases and trigger a wider trade war with escalating tit-for-tat tariffs. The adverse implications for both global and US growth would then be more severe. 

While the next round of trade discussions plays out, however, it’s time for the administration—and for investors—to shift attention and focus to taxes and deregulation. Progress in these areas would be crucial to offset the damage from tariffs. Against this background, I do see US GDP growth lower this year given the damage already done in the first quarter and the weakness likely to persist into the early second quarter. I also see upside risks to inflation, albeit as a temporary shock of 1.25-1.50 pp. On balance, I maintain my Federal Reserve (Fed) call of at maximum one rate cut for the remainder of the year. Assuming we will see concrete action on deregulation and incremental tax cuts, I think the balance of inflation and growth risks will counsel the Fed to refrain from greater rate cuts. On this basis, and with the caveat on global growth uncertainty mentioned above, risks to US Treasury yields appear to be to the upside.