Today we are diving into the topic of tariffs and their impact on the US economy and markets. We are going to discuss what tariffs are, run through a brief history of tariffs and how other countries are using them, and wrap up with a quick discussion on how they might impact the economy as well as the markets.
Tariffs have been a hot topic in the news and understanding them is crucial for grasping how international trade affects our daily lives.
What are tariffs?
Tariffs are taxes imposed by the government on imported and sometimes exported goods and services. They are typically calculated as a percentage of the item's value. Tariffs can be used for several purposes: to make imported goods more expensive to encourage consumers to buy domestically produced products; to provide revenue for a government; and to negotiate with other countries.
There is a great explanation of U.S. tariff policy titled, “US Tariff Policy: Overview” at crsreports.congress.gov. In that report dated January 31, 2025, the rules-based global trading system adapted by the World Trade Organization (WTO) is outlined. It describes the system’s core rules with regards to tariffs, which are nondiscrimination, binding commitments, transparency, and safety valves. It also describes how U.S. tariff policies are made and have evolved over time.
A Brief History of U.S. Tariffs
There has been a back-and-forth shift of responsibility between congress and the President over the years. However, the most recent rules delegated extensive tariff-setting authority to the President.
While tariffs have never accounted for much more than 2% of the total federal revenue, according to an article posted by CNBC (cnbc.com), from our foundation as a country up to the Civil War, the U.S. relied on tariffs for about 90% or more of its revenue. After the Civil War, the U.S. began using excise taxes and other taxes to reduce reliance on tariffs to about 50% of our revenue. Once the income tax was created in 1861 by Congress, through the encouragement of Abraham Lincoln (history.com), we began relying less on tariffs.
Over time, their role has evolved, and they are now primarily used as a tool of trade policy. For example, in recent years, the US has imposed tariffs on a range of Chinese goods as part of the ongoing trade disputes between the two countries. One of the interest differences in these negotiations today is the discussion about impeding the flow of illicit drugs from China through the Mexican and Canadian borders.
The primary impacts tariffs have on the economy may primarily be on trade, domestic industries, consumer prices and purchasing power, employment, and economic growth. I am basing this on what has historically happened, so much of this is speculation.
Potential Economic Impacts
Trade
One potential impact of tariffs is a reduction in imports. Since they make imported goods more expensive, tariffs can lead to a reduction in imports as consumers and businesses seek alternatives. This can benefit domestic industries that compete with foreign suppliers by decreasing foreign competition.
Another potential impact on trade is a Retaliatory tariff. When one country imposes tariffs on another country’s imports, often the other country will respond by imposing or increasing tariffs. This is often referred to as a tariff war.
Domestic Industries
Domestically, and arguably one of the biggest reasons for implementing tariffs, there can be the effect of protecting industries that are threatened by lower cost imported goods. Globalists might argue that it is okay for goods to shift from less efficient economies to countries that can produce goods at a lower cost. However, some industries are essential to national security and tariffs are a way to keep those industries going in the face of import threats.
Higher Production Costs can result from tariffs for the same reasons mentioned above. If other countries can produce goods at lower costs but are forced to increase those costs through tariffs, production costs can increase.
Consumer Prices and Purchasing Power
Increased consumer prices are possible, as businesses will often pass along the increased costs of imports.
The SUBSTITUTION EFFECT is another potential impact, as consumers may shift their spending to domestically produced alternatives.
Employment and Job Market
Tariffs can lead to job creation in protected industries by reducing competition and increasing demand for domestic products. This can revitalize sectors such as steel, aluminum, and manufacturing, contributing to economic growth.
The converse can be true for export-dependent industries. Those industries that rely on exports may suffer from retaliatory tariffs, leading to job losses. Sectors especially vulnerable to tariff wars are the agricultural sectors, technology companies, and automotive manufacturers.
Overall Economic Growth
In the short term, tariffs can stimulate economic growth by protecting domestic industries and creating jobs. However, the long-term effects can be detrimental, as increased production costs, reduced export opportunities, and higher consumer prices can stifle economic expansion.
Uncertainty surrounding trade policies and potential tariffs can deter investment, as well. Businesses may be hesitant to invest in new projects or expand operations if they are concerned about future tariffs, which can slow economic growth and innovation.
Potential Market Impacts
So, how can tariffs impact the market?
The primary potential market impacts are on stock market volatility, sector-specific impacts (positive and negative), and potential long-term effects on certain industries or sectors.
Tariffs can create uncertainty in the financial markets. Investors may react to news of tariffs and trade disputes by selling stocks, leading to market volatility. Companies that rely heavily on international trade can see their stock prices fluctuate significantly.
Certain sectors may be affected more by tariffs than others. For instance, the technology sector, which relies on a global supply chain, can be particularly vulnerable to disruptions caused by tariffs. Likewise, the agricultural sector can suffer from reduced export opportunities.
While tariffs can provide short-term protection for domestic industries, as discussed earlier they can also lead to inefficiencies in the economy. Over time, businesses may become less competitive globally if they rely on tariff protection rather than innovation and efficiency.
Summary
Tariffs can be a double-edged sword. While they can protect domestic industries and generate government revenue, they may also lead to higher prices, inflation, and potential trade wars. The impact on the US economy and markets is complex and multifaceted, affecting consumers, businesses, and investors alike.