Turn on any news outlet, or pick up any news publication today and you’re likely to see or read about the tariffs that the U.S. has recently imposed on goods imported from China. Most people covering this developing story refer to what’s going on as a trade war. And most oversimplify the situation and exaggerate the potential impacts. So, we thought it would be a good idea to give an unbiased, non-political, review of tariffs. What they are, when they are good and when they are bad, what effects they tend to have on the economies of the imposing countries, and what effects they have on the economies of the countries having the tariffs imposed on their goods. We’ll leave the hyperbole out of the discussion.
The Basics of Tariffs
Let’s start with the basics of what a tariff actually is. A tariff is a tax on imports or exports between countries. Today, the use of tariffs is generally to make imported products or services more expensive. Thereby discouraging the purchase of the imports, and encouraging the purchase of domestic versions of those products or services. Which ostensibly boosts the country’s economy. Tariffs have been around for centuries and were the source of income for the U.S. government in the late 1700s. Back then, Congress had no authority to levy taxes on citizens. Their only other means of income was to seek money from the individual states.
Tariffs are generally thought of as protectionist policies. For the simple reason, their goal is the protection of a particular domestic industry and/or economy. Nearly all sovereign nations today impose tariffs on some or all of the products of the countries they trade with. China, Mexico, Canada, the EU, and the United States are the most high profile examples.
Tariffs can also be indirectly levied by government subsidies to particular industries, and by currency manipulation, or a combination of the two. Currency manipulation is what is referred to in economic terms as currency dumping. If you flood the market with your currency, at some point the value will decline because there is more of it in circulation than there is demand for it. So, stuff bought from your country becomes cheaper than the same stuff from another country who isn’t manipulating their currency.
China and Tariffs
China, for example, has historically manipulated the value of their currency to keep its value low. By the time China ended its currency manipulation in the last 4 years or so, most estimates say their currency was about 30-40% below its true value. This had the (intended) effect of making Chinese goods less expensive, thereby encouraging people to import those lower cost goods rather than producing them locally.
That incentive took money, jobs, and economic growth, from the importing countries…the U.S. included…and sent them to China. It’s been a massive transfer of wealth from other countries to China.
In addition to currency manipulation, China imposes direct tariffs on goods coming into their country from the U.S. China also subsidizes much of their industry, which makes the trade between our two countries even less equitable. This is where the recent tariffs recently announced come in to play. The term “trade war” is getting used more often than the word “like” at a teenage birthday party, and where cooler heads should prevail.
Someone Has to Pay
Remember that tariffs are taxes. Someone has to pay them. That someone is almost always the end user of the imported items…i.e., the consumer. The big question on everyone’s mind is; “What will the economic impact of the tariffs be, and aren’t the American consumers going to be on the hook for this tax increase?”
First, the economic impact. If the recently announced tariffs (25% on 200 billion dollars’ worth of Chinese products) are left in place indefinitely, it’s likely that the domestic production of those products will increase to meet the demand, and the local economies where those goods are produced will expand. But that ignores the intent of the tariffs in the first place. The intention is that they are temporary.
The goal is to have China ultimately agree to much fairer trade agreements with the U.S. and to have them buy more U.S. goods. Currently, the U.S. exports less to China than we do to Japan, South Korea, and Singapore combined. So even if this actually turns into a full-blown trade war and China outright bans the import of all U.S. goods, it would amount to little more than ½ of 1 percent of our GDP. But that’s not going to happen, because we are the single biggest consumer of Chinese goods. A trade war with the U.S. isn’t in their interest.
What About Taxes?
And what about the tax increase the tariffs are going to impose on the consumer?
Let’s do the math. An increase from 10% to 25% on the tariff on 200 Billion dollars in goods equals 30 Billion dollars. Not a small number to be sure, but Americans paid the government 5.51 TRILLION dollars in taxes last year between federal, state, and local. The additional 30 Billion dollars is equal to an increase of .00544%. Insignificant at best.
Tariffs
For perspective, the stock market drop on Monday erased roughly 700 Billion dollars in value from the stock market. And, if the U.S. were to enact a 25% tariff on the entire basket of goods that we import from China annually, the tax increase would be a still minor 135 billion dollars a year or .0245%.
This is not to say that tariffs are a good long term economic policy. They aren’t. The intent here is to keep things in their proper perspective and let cooler heads prevail.
If I’m correct, and this is all for China’s consumption to get them to play ball, this will be a short-lived event. But even if it isn’t, you’re now armed with the information you need to keep this developing saga in perspective and keep your focus on things that matter to you.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.