Liberation Day Tariffs

The Trump tariffs are roughly equivalent to the Smoot-Hawley tariffs enacted nearly 100 years ago at the start of the great depression. The primary difference between the “Liberation Day” announcement and the historical record lies in the scale of import reliance within the U.S. economy. Currently, the U.S. imports goods equivalent to about 14% of GDP—substantially higher than the approximately 4% observed when tariffs were at comparable levels one hundred years ago. The other key difference is that when the Smoot-Hawley tariffs were enacted, the U.S. was a net exporter of goods - we couldn't consume everything we produced. Today, the U.S. is a net importer of goods, i.e. we consume more than we produce (goods, not services).

The notion that the economy consists primarily of making, selling, and consuming tangible things was mostly true when President William McKinley levied tariffs in the 1890s. Today, services account for about 80% of U.S. gross domestic product and jobs. Even in Germany—Europe’s manufacturing leader—GDP is 70% services. Much of the economic strength of the U.S. can be attributed to our service sector. While we have a $1.2 trillion annual trade deficit in goods, we have a nearly $300 billion annual surplus in services which is not included in the tariff calculations. Oh, and service jobs pay 25% more than the average manufacturing job.

Tariffs are revenue generators for the government - they are a form of taxation. This policy shift represents the most significant tax increase since the 1968 levies to fund the Vietnam War. It's likely the tariffs are intended as a mechanism to offset revenue loss from extending the tax cuts, with the administration seeking to make the 2017 TCJA tax cuts permanent. A back-of-the-envelope calculation suggests that the tariffs could be as large as 2 percent of annual GDP. If so, this tax increase would be larger than the expiring 2017 tax cuts that Trump is trying to extend.

Our tax system is much more progressive than most people realize. Low-income US taxpayers have a negative effective tax rate. Millions of Americans actually receive money from the IRS, largely due to tax credits (major US tax credits listed at the bottom of this page). For taxpayers with AGIs between $1 and $15,000, their average effective tax rate fell to -14.8%, from -10.3% in 2019, largely due to coronavirus pandemic-related federal relief efforts, some of which were structured as tax credits. [1] Collectively, taxpayers in the bottom 50% of AGI pay only 3% of US total income tax while the top 50% pay 97%.[2]

Tariffs apply equally to all, but lower income people spend a higher percentage of income on goods compared to high income people, so the overall effect is somewhat regressive. Using tariffs as a consumption tax, and lowering taxes for the top 50% of AGI filers, the effect is a less progressive tax system. Of course it's not obvious to lower income filers what is happening since tariffs are opaque - they are basically a "hidden" consumption tax, they don't appear on your receipt.

The announced tariffs were much broader and higher than expected. The market view is that a likely result will be higher costs for U.S. companies and consumers, a decrease in U.S. competitiveness, and a net loss for the global economy as growth slows materially. Financial markets across the globe are reflecting those concerns.

When economic growth slows as expected, the Fed will likely lower rates - more, and faster - than we expected prior to the tariff announcement. That is, the Fed will shift to prioritize economic growth over inflation concerns. Longer term yields could move decisively lower even before the Fed can act, as recession probabilities increase. Note that lowering interest rates directly lowers the borrowing costs of our government. This is very important given the U.S. debt stands at $36 trillion, or more than 120% of annual economic output (GDP), and is rising fast as the government spends more than it raises in taxes.

In a vastly oversimplified view, imagine the cost of a car going up $3,000 due to tariffs, but the cost of financing the car going down $3,000 due to lower interest rates. Tariffs are also a means to reduce domestic consumption (forcing people to spend less) and force up domestic savings rates - in other words, maybe you don't buy the car at all. No one knows how this will all play out...

How Trump's Tariffs were Calculated:

• Even for countries like Australia where we have a trade surplus, the tariff is 10%. There is a 10% "base rate" on all countries.
• In calculating the tariff rate, Trump's people only used the trade deficit in goods. So even though we run a trade surplus in services with the world, those exports don't count as far as Trump is concerned.
• Here's how the tariff rates were calculated - for every country, they just took our trade deficit with that country and divided it by the country's exports to us. We have a $17.9 billion trade deficit with Indonesia. Its exports to us are $28 billion. $17.9/$28 = 64%, which Trump claims is the tariff rate Indonesia charges us (not true). Then the tariffs were set by cutting that rate in half.
• Further evidence that deep thought was not put into these tariffs is the fact that the Heard and McDonald Islands are among the dozens of targets of President Donald Trump's latest round of tariffs. But they have no exports, because no one lives there - they are in Antarctica. We even put a 30% tariff on Nauru (a tiny island of less than 11k people) where we have a "$0 billion" trade deficit by Trump's own figures. No, I don't know where Nauru is, and no I can't explain the math either given the formula above.
• Because this is so obviously ridiculous, one can only assume the rates are not meant to be "real" or lasting, but only to drive some countries to the bargaining table, or simply to raise taxes, and depress consumer demand so the Fed can lower interest rates faster.

Considerations

• The idea that tariffs will drive onshoring of manufacturing is very unlikely. It took decades for some US manufacturing and services to migrate offshore. It'll take decades to reverse, assuming companies believe these tariffs are permanent (they aren't), and they can find and train US workers at a reasonable cost.
• Tariffs are also a two-way street. What incentive does a company have to move a multi-billion dollar auto manufacturing facility ~to the USA when it may [likely will] face reciprocal tariffs on any exported goods from the USA?
• Assume a company does move production back to the US - How much do production workers get paid in China compared to American workers? How will our locally produced goods be affordable at American labor rates? Unless the tariffs are "forever", and US consumers are OK with goods being more expensive "forever" the math doesn't work.

Summary Thoughts

"Tariffs are taxes that uneducated people don’t understand, can’t see, and can be implemented by the executive branch without congressional approval."

So far, we have relied on the Fed to raise interest rates to depress consumer demand and tamp down inflation, however this means when the US rolls over its debt our interest payments will skyrocket. We were all hoping inflation would be less sticky, and drop faster, so the Fed could lower interest rates back down quickly but that was not the case.

Tariffs are another means to both raise US taxes to balance our budget and tamp down consumer demand so the Fed can lower interest rates (the Fed will likely "look through" the inflation caused by the tariffs). Lower rates will help the US government [re]finance its debt, and lower rates will also help the economy grow.

Time is short, however. The administration only has about 12-16 months to get this right before the mid-term election cycle. If the economy is not growing, and inflation is not under control, the Democrats will likely win seats in both houses of Congress and be able to play defense until the next presidential election. "It's the economy stupid" is the mantra of every election cycle...

There is always the possibility that the economic and political cost of tariffs spur a policy pivot and/or mutually acceptable trade agreements are eventually reached among the major players such that the worst of outcomes, which are in no one’s interests, are avoided.

The major existential risk, however, and the golden prize for America's enemies is to reduce or remove the US dollar as a global reserve currency. This would be the coup de grace on this country's hegemony.

One should pay close attention both to the surprising rise in Treasury bond yields and to the decline in the value of the US dollar to a three-year low against the euro. Both trends could prove to be canaries in the coal mine regarding global investors turning their back on the United States as a safe haven.

For the first time in recent memory, the American dollar is not the automatic “flight-to-safety” currency, sought out by investors worldwide during crisis periods and in moments of acute uncertainty. Furthermore, foreign investors appear to be reappraising the role of U.S. Treasury securities as a global haven asset as concerns mount over the capricious nature of Trump’s policymaking. To preserve dollar’s global status, economic historian Barry Eichengreen notes that Trump “should be promoting financial stability, limiting the use of tariffs, and strengthening America’s geopolitical alliances.”

Instead, the Trump administration is playing a dangerous game as it actively tries to weaken the dollar. Incoherent tariff policies and geopolitical misfires may hasten a global financial realignment and threaten America’s financial primacy.

“...by placing massive and disproportionate tariffs on our friends and our enemies alike and thereby launching a global economic war against the whole world at once, we are in the process of destroying confidence in our country as a trading partner, as a place to do business, and as a market to invest capital.”

— Bill Ackman, CEO Pershing Square

UPDATE 2025/04/12

Trump pushed out all tariffs 90 days (except for a 10% base tariff) and China. "USA Against the World" has become USA vs. China. China now faces a tariff rate of 145% on its exports to the United States. China retaliated Friday (04/11/2025) applying 125% levies on U.S. goods, but signaled it would apply no further measures in the future. China's perspective is "given the current level of tariffs, U.S. goods exported to China are no longer market-viable".

When it comes to the US-China trade war, there is a unique dynamic at play. In 1972, China had no trade with the US. In 1980, four years after Mao Zedong’s death, China’s per capita economic product was less than one-quarter of the Nigerian mean; there were no private passenger cars; only the top Communist Party leaders living in the seclusion of Zhongnanhai (the former imperial garden within the Forbidden City, now the central headquarters of the Communist Party) had air conditioning. 1984 was the last year the US had a surplus trading goods with Beijing; in 2009, China became the world’s largest exporter of goods; and by 2018 its exports accounted for more than 12 percent of all global sales, and its trade surplus with the US reached nearly $420 billion. China's rise has been meteoric, and its trade relationship with the US has become increasingly complex.

While both countries would suffer greatly in a prolonged trade war, the US appears to maintain more structural leverage due to its financial dominance, diverse export markets, stronger alliance system, and China's greater export dependency. However, China's ability to weather short-term economic pain and coordinate policy responses should not be underestimated.

The most significant US vulnerability is its political division and potential unwillingness to accept economic sacrifices. Trump has already blinked by pushing the tariffs on other countries out by 90 days, and late Friday afternoon it was announced that semiconductors, flat-panel displays, laptops, smartphones and memory chips would be excluded from the China tariffs. According to the linked Reuters article smartphones were the top U.S. import from China in 2024, totaling $41.7 billion, while Chinese-built laptops were second, at $33.1 billion, according to U.S. Census Bureau data. So Trump has already caved on the most important items imported from China.

China State media reported that President Xi Jinping will visit Vietnam, Malaysia and Cambodia next week, a sign the Chinese leader wants to strengthen ties with Asian trading partners. All three countries were slapped with very high U.S. tariffs this month, and all subsequently said they wish to negotiate with the Trump administration. If China can stonewall and wait this out they will have won a major victory. If they don't come to the negotiating table it seems likely that Trump will be forced to back down further. Everyone in the world is watching to see how this plays out.

UPDATE 2025/04/23

Yesterday Treasury Secretary Scott Bessent told investors that the US-China trade war is unsustainable and he expects the battle to de-escalate. Later, Trump said in a session with reporters in the Oval Office. “145% is very high and it won’t be that high, it won’t be anywhere near that high. It’ll come down substantially. But it won’t be zero.”

Notably, China has made no move to come to the negotiating table. China has kept up it's own pressure—adding more American companies on its export control list and unreliable entity list, and restricting the export of critical minerals. Beijing also restricted the number of Hollywood movies shown in the country and returned at least two Boeing jets to the US.

The Chinese government has been very clear that they will not negotiate with the US under duress. They are waiting for the US to blink first. Asked about Trump and Bessent’s comments on Wednesday, China’s Foreign Ministry said the US should “stop its threats and coercion, and engage with China on the basis of equality, mutual respect and reciprocity” if it wants to make a deal.

Trump’s shift in tone went viral on the Chinese internet. On Wednesday, the hashtag “Trump chickened out” was trending as a top topic on social media platform Weibo, racking up more than 150 million views.

UPDATE 2025/05/01

China on Tuesday vowed it would “never kneel down” in the face of President Donald Trump’s tariff pressure because “bowing to a bully is like drinking poison to quench thirst,” painting itself as a champion for the international community. A video released by the Ministry of Foreign Affairs is the latest example of Beijing’s defiant response to Trump’s trade war and its efforts to portray itself as a defender of free trade and globalization. Wang Yi, China’s top diplomat, hammered home a similar message at a BRICS meeting on Monday in Brazil, where he emphasized China’s role as a defender of free trade and multilateralism.

The Chinese government is very good at playing the long game, and they are willing to wait out the US. However, no one wants a prolonged trade war, and this rhetoric makes it challenging for both countries. The reality is that both sides will suffer in a prolonged trade war, and both sides will eventually have to come to the negotiating table. In the next several weeks retail items on US shelves will either fail to be restocked or the prices will rise and consumers will begin to feel the effects of the tariffs. We will see if the US and China can find a way to de-escalate the situation without losing face.

UPDATE 2025/05/19

The Trump administration recognized that China was standing firm, and that U.S. consumers would soon face either higher prices or empty shelves. In response, it called a meeting with Chinese officials over Mother’s Day weekend in Geneva, Switzerland, and agreed to a temporary truce. This de-escalation of tariffs is expected to last 90 days while both sides negotiate a more permanent solution. As a result, U.S. markets rallied sharply on optimism that cooler heads were finally prevailing.

However, the damage to America's reputation had already been done. Combined with fears of higher deficits driven by the Trump administration’s proposed budget and tax cuts, this led to a downgrade of the U.S. credit rating by Moody’s. On Friday, the agency cut its rating from AAA to Aa1, citing concerns about the country’s fiscal health and persistent political gridlock. The downgrade reflects growing doubts about the federal government’s ability to manage its debt effectively—especially in light of the recent tax cuts and spending increases.

Moody’s warned that extending President Donald Trump’s 2017 tax cuts—now a key priority for the Republican-led Congress—would add $4 trillion to the federal primary deficit over the next decade.

Moody’s is the third and final major credit rating agency to lower its assessment of the federal government's creditworthiness. Standard & Poor’s issued its first-ever downgrade in 2011, followed by Fitch Ratings in 2023. As a result, the United States no longer holds a top-tier credit rating from any major agency—for the first time in over a century.

Today, May 19th, investors are selling U.S. stocks, bonds, and dollars—an ugly combination that signals growing pessimism about the outlook for the world’s largest economy. Although higher interest rates typically strengthen the U.S. dollar, the currency declined today against the euro, yen, and others. This suggests that investors may be losing confidence not just in U.S. assets, but in the US dollar specifically.

UPDATE 2025/05/24

US Treasuries, once regarded as the safest investment in the world, have lost that status. Apple now has a better credit rating than the U.S.A. (as do Microsoft and Johnson & Johnson). Apple actually makes products people want, makes money doing so, and Apple has a healthy balance sheet, with $132.9 billion in cash and marketable securities. The U.S. government, on the other hand, has a $36 trillion debt and is running a $1.7 trillion deficit this year alone. Which would you rather own?

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Table: Largest US Tax Credits (2024/2025)

The effect of tax credits on low- to moderate-income filers are profound. These credits can significantly reduce tax liability and, in many cases, result in a refund even if no taxes were paid. For example, a single parent with two kids earning $25,000 could receive a "refund" of over $6,000, mostly due to EITC and CTC.

1. Earned Income Tax Credit (EITC)

   • Up to $7,430 for tax year 2023 (higher for 2024).
   • For low-to-moderate-income working individuals and families, especially with children.
   • Refundable.
   • Phases out at higher income levels.

2. Child Tax Credit (CTC)

   • Up to $2,000 per child under 17.
   • Up to $1,600 may be refundable as the Additional Child Tax Credit (ACTC).
   • Income limits apply.
   • May be increased under future legislation (was temporarily $3,600 during COVID relief).

3. American Opportunity Tax Credit (AOTC)

   • Up to $2,500 per eligible student per year for qualified education expenses.
   • 40% is refundable (up to $1,000).
   • Phases out for higher-income taxpayers.

4. Premium Tax Credit (ACA)

   • Covers a substantial portion of health insurance premiums purchased on Healthcare.gov.
   • Size varies widely based on income and family size.
   • Can be worth thousands per year.

5. Saver’s Credit (Retirement Savings Contributions Credit)

   • Up to $1,000 ($2,000 for joint filers).
   • For low- to moderate-income taxpayers contributing to IRAs or 401(k)s.
   • Non-refundable

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References

• 1: Pew Research: Who pays, and doesn’t pay, federal income taxes in the U.S.?
• 2: Tax Shares in Tax Year 2022
• 3: What is the national debt?
• Foreign Affars: How Tariffs Can Help America
• Reuters: Markets wrestle with Trump's unconventional debt ideas
• Stephen Miran: A User’s Guide to Restructuring the Global Trading System
• WTO: World Tariff Profiles 2024
• Dollar collapse: The crisis is no longer just theoretical
• NYT: Markets Rattled on Concerns About U.S. Debt
• NYT: U.S. Downgraded by Moody’s as Trump Pushes Costly Tax Cuts
• Barrons: Apple or America? The iPhone Maker Now Has a Better Credit Rating Than the U.S.