Early last month President Donald Trump announced a plan to levy tariffs of 25% on steel and 10% on aluminum imports coming into the US. This announcement followed a Commerce Department report from January that concluded a reliance on imported steel threatens national security by weakening the American industrial base. According to the President, “… You will have protection for the first time in a long while, and you’re going to re-grow your industries.” The tariffs went into effect in late March.
This policy seems like a break from traditional US policy of free trade but we actually have a long history with tariffs. In fact, the very first legislation ratified by the first US Congress under the newly adopted Constitution was the Tariff Act of 1789. This act was championed by Alexander Hamilton and James Madison, and signed into law by President Washington. The primary purpose of the tariff, however, was not trade protection but rather to generate revenue for the fledgling Federal government and to pay Revolutionary War debt obligations. Most imported goods were taxed around 5%. Until the federal income tax became permanent in 1913, tariffs remained an important source of funding for the US government, generally accounting for 50% or more of the federal budget.
It wasn’t until 1816 that “protectionism” became central to US trade policy when the cost to import foreign goods rose to 20%-25% explicitly to protect US manufacturing from foreign competition. During the Civil War, the Confederate States of America hoped their own 15% tariff would help fund the cost of the war. The Union blockade, however, locked up the southern coast and the CSA was only able to collect $3.9 million in total. Tariffs remained a hot-button topic of debate with tariffs moving up and down sharply until the dawn of the free trade era following World War II.
William McKinley campaign posterca. 1896, Library of Congress
With tariffs, there is always a tradeoff. High tariffs raise the cost of foreign imports, allowing domestic industries to grow, develop and become more efficient, but this benefit comes at a literal cost to consumers who are forced to pay higher prices on those goods.
Part of what makes the current protectionist policies unusual is that historically, tariffs have repeatedly come up during rough patches for the economy. William McKinley’s 1896 and 1900 presidential campaigns were based on the promise to implement tariffs to rescue domestic manufacturers, save jobs and resolve deep recessions. He won both elections in landslide victories.
The Smoot-Hawley tariff of 1930 came shortly after the market crash of 1929. The act raised tariffs on over 20,000 imported goods and led to one of the most difficult trade wars in US history. The international reaction was swift. Canada, Britain, Germany, France, and others retaliated by levying heavy tariffs against imports from the United States. Many of these countries also reached bilateral trade deals with each other, effectively diminishing the need for some US goods once the trade wars ended. Our own exports fell by nearly two-thirds over the next two years. Most economic historians agree that while Smoot-Hawley may not have been the cause of the Great Depression, it most certainly amplified and prolonged it.
Before World War II ended, representatives from 44 allied nations met in Bretton Woods, New Hampshire for the Bretton Woods Conference to lay the groundwork for moving the world toward free trade. The initial agreements that emerged from the conference led to the establishment of the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). Later trade agreements which were formed on the basis of reciprocity included the General Agreement on Tariffs and Trade in 1947 (GATT), which later became the World Trade Organization (WTO). All member nations agreed to grant mutual concessions on tariff rates and quotas. If one nation diverged from free trade, other nations would respond in kind. The chart below illustrates the effect lower trade barriers have had on the US trade balance since GATT in 1947. The Bretton Woods era ended when the US decided to abandon the gold standard allowing currency prices to fluctuate more based on market forces.
Before World War II ended, representatives from 44 allied nations met in Bretton Woods, New Hampshire for the Bretton Woods Conference to lay the groundwork for moving the world toward free trade. The initial agreements that emerged from the conference led to the establishment of the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). Later trade agreements which were formed on the basis of reciprocity included the General Agreement on Tariffs and Trade in 1947 (GATT), which later became the World Trade Organization (WTO). All member nations agreed to grant mutual concessions on tariff rates and quotas. If one nation diverged from free trade, other nations would respond in kind. The chart below illustrates the effect lower trade barriers have had on the US trade balance since GATT in 1947. The Bretton Woods era ended when the US decided to abandon the gold standard allowing currency prices to fluctuate more based on market forces.
Tariffs or trade restrictions can be politically targeted, and often have unintended consequences and politically-driven long lives. For example, in 1963, Germany and France raised tariffs on US chicken imports and President Lyndon Johnson responded by levying a 25% tariff on some imports including potato starch, dextrin, brandy and light trucks. The 25% tariff on light trucks, referred to as “The Chicken Tax,” was designed to directly target imports from Volkswagen, one of Germany’s largest companies. The Chicken Tax remains to this day and this is why Ford and Chevy dominate the truck market in the US. It also explains why Toyota and other foreign truck manufacturers have located manufacturing facilities in the US where the tariff can be avoided due to domestic production. It also gave us the Subaru BRAT in 1978 with impossibly impractical back seats that technically made it a car and not a truck.
Subaru BRAT
Steel has long been a popular target for protectionism. Nearly every country views steel as a vital industry and many have enacted policies to promote domestic production. More recently, President George W. Bush raised tariffs on steel to 30% in 2002 and once again there was retaliation. After the WTO deemed the tariffs illegal, several European countries responded with tariffs that directly targeted states that were carried by Bush in the 2000 presidential election. Election interference? Among the many tariffs imposed on the US, taxes on textiles directly hit mills in North Carolina while orange juice tariffs harmed Florida’s agriculture.
Protection from the “dumping” of low-priced goods and other anti-competitive policies is usually the justification for raising tariffs. What makes President Trump’s steel and aluminum tariffs unusual is the argument of national security, which has not really been used since the fall of the Soviet Union. In fact, the four largest sources of US steel imports, Canada, Brazil, South Korea, and Mexico are all US allies. Canada and Mexico have been granted a temporary exemption from the new tariffs but so far they have only been granted 30-day exemptions. We’ve yet to hear from the WTO.
In case you missed it, here is a timeline of tariff action and tough talk so far in 2018:
January 2018—The US announces a 30% tariff on imported solar panels, most of which come from China, and taxes on large residential washing machines starting at 20%. Other affected countries, including South Korea and Mexico, threaten varying degrees of retaliation to the tariffs.
February 2018—The US Commerce Department, led by Commerce Secretary Wilbur Ross, proposed a range of tariffs including 24% on steel and 7.7% on aluminum. China said it will “take necessary measures to defend our rights” if it is hit with tariffs.
March 9, 2018—Trump follows through on the tariffs recommended by his commerce department, taxing steel imports at 25% and imported aluminum at 10%. US neighbors Canada and Mexico are exempted from the tariffs, with Trump saying other countries could potentially receive similar exemptions if they can “ensure that their products no longer threaten our security.”
April 2, 2018—China imposes tariffs on US imports worth $3 billion, including a 15% duty on 120 American products including fruits, nuts, wine and steel pipes and a 25% tax on eight others, including recycled aluminum and pork.
April 3, 2018—US threatens to target another $50 billion in Chinese goods.
April 4, 2018—China warns of tariffs on another $50 billion in American goods.
April 5, 2018—Trump calls for targeting another $100 billion in Chinese goods.
April 13, 2018—Trump tells his advisors to study re-opening talks regarding joining the Trans-Pacific Partnership.
As in past trade spats, some of the announced tariffs are politically targeted. For example, the Chinese tariffs on soybeans, sorghum, and live hogs are designed to directly target Trump’s political base.
On its face it looks like a trade war is heating up. But history has demonstrated that there is much to lose if this escalates. Recent stock market volatility has clearly signaled that this time is no different. Trump’s economic team has thus far soothed investors by explaining that the tough talk and actions so far are part of intense, behind-closed-doors negotiations with China. Hopefully that is true. China accounts for the largest share of US imports from any country. A trade war with China alone will lead to increased prices for many goods in the US over the short term. If Canada and Mexico, our next two largest sources of imports, decide to respond, things could deteriorate rapidly.
The President has repeatedly said he will take a firm stance to protect the competitiveness of US economic interests. Early in his presidency, Trump kept a campaign promise and withdrew from the Trans-Pacific Partnership (TPP), which included China, Japan, Australia, Canada, and Mexico and which would have created the largest economic bloc in the world. The President has made the case that China is the guilty party by correctly pointing out that China has long given government support to industrial and manufacturing development that has allowed Chinese firms to sell goods at lower prices than most competitors. Chinese firms have also been very active in buying competitive advantage in recent years through acquisitions of foreign technology companies. While the WTO is charged with maintaining reciprocity in trade, actually proving that China’s actions are anti-competitive is difficult. President Trump has clearly decided to go it alone. Trump claims he is a great negotiator and that “trade wars are easy to win.” I guess we’re going to find out if he’s right. In the meantime, buckle up for more market volatility.
The information included in this article and the Tax Foundation tax-estimator tool are for informational purposes. Please consult your tax advisor before acting on this information.
Welcome Jen Muckley to the Bragg Team
April 2, 2018Chained CPI Explained and the Impact on the New Tax Act
April 20, 2018Early last month President Donald Trump announced a plan to levy tariffs of 25% on steel and 10% on aluminum imports coming into the US. This announcement followed a Commerce Department report from January that concluded a reliance on imported steel threatens national security by weakening the American industrial base. According to the President, “… You will have protection for the first time in a long while, and you’re going to re-grow your industries.” The tariffs went into effect in late March.
This policy seems like a break from traditional US policy of free trade but we actually have a long history with tariffs. In fact, the very first legislation ratified by the first US Congress under the newly adopted Constitution was the Tariff Act of 1789. This act was championed by Alexander Hamilton and James Madison, and signed into law by President Washington. The primary purpose of the tariff, however, was not trade protection but rather to generate revenue for the fledgling Federal government and to pay Revolutionary War debt obligations. Most imported goods were taxed around 5%. Until the federal income tax became permanent in 1913, tariffs remained an important source of funding for the US government, generally accounting for 50% or more of the federal budget.
It wasn’t until 1816 that “protectionism” became central to US trade policy when the cost to import foreign goods rose to 20%-25% explicitly to protect US manufacturing from foreign competition. During the Civil War, the Confederate States of America hoped their own 15% tariff would help fund the cost of the war. The Union blockade, however, locked up the southern coast and the CSA was only able to collect $3.9 million in total. Tariffs remained a hot-button topic of debate with tariffs moving up and down sharply until the dawn of the free trade era following World War II.
William McKinley campaign posterca. 1896, Library of Congress
With tariffs, there is always a tradeoff. High tariffs raise the cost of foreign imports, allowing domestic industries to grow, develop and become more efficient, but this benefit comes at a literal cost to consumers who are forced to pay higher prices on those goods.
Part of what makes the current protectionist policies unusual is that historically, tariffs have repeatedly come up during rough patches for the economy. William McKinley’s 1896 and 1900 presidential campaigns were based on the promise to implement tariffs to rescue domestic manufacturers, save jobs and resolve deep recessions. He won both elections in landslide victories.
The Smoot-Hawley tariff of 1930 came shortly after the market crash of 1929. The act raised tariffs on over 20,000 imported goods and led to one of the most difficult trade wars in US history. The international reaction was swift. Canada, Britain, Germany, France, and others retaliated by levying heavy tariffs against imports from the United States. Many of these countries also reached bilateral trade deals with each other, effectively diminishing the need for some US goods once the trade wars ended. Our own exports fell by nearly two-thirds over the next two years. Most economic historians agree that while Smoot-Hawley may not have been the cause of the Great Depression, it most certainly amplified and prolonged it.
Before World War II ended, representatives from 44 allied nations met in Bretton Woods, New Hampshire for the Bretton Woods Conference to lay the groundwork for moving the world toward free trade. The initial agreements that emerged from the conference led to the establishment of the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). Later trade agreements which were formed on the basis of reciprocity included the General Agreement on Tariffs and Trade in 1947 (GATT), which later became the World Trade Organization (WTO). All member nations agreed to grant mutual concessions on tariff rates and quotas. If one nation diverged from free trade, other nations would respond in kind. The chart below illustrates the effect lower trade barriers have had on the US trade balance since GATT in 1947. The Bretton Woods era ended when the US decided to abandon the gold standard allowing currency prices to fluctuate more based on market forces.
Before World War II ended, representatives from 44 allied nations met in Bretton Woods, New Hampshire for the Bretton Woods Conference to lay the groundwork for moving the world toward free trade. The initial agreements that emerged from the conference led to the establishment of the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF). Later trade agreements which were formed on the basis of reciprocity included the General Agreement on Tariffs and Trade in 1947 (GATT), which later became the World Trade Organization (WTO). All member nations agreed to grant mutual concessions on tariff rates and quotas. If one nation diverged from free trade, other nations would respond in kind. The chart below illustrates the effect lower trade barriers have had on the US trade balance since GATT in 1947. The Bretton Woods era ended when the US decided to abandon the gold standard allowing currency prices to fluctuate more based on market forces.
Tariffs or trade restrictions can be politically targeted, and often have unintended consequences and politically-driven long lives. For example, in 1963, Germany and France raised tariffs on US chicken imports and President Lyndon Johnson responded by levying a 25% tariff on some imports including potato starch, dextrin, brandy and light trucks. The 25% tariff on light trucks, referred to as “The Chicken Tax,” was designed to directly target imports from Volkswagen, one of Germany’s largest companies. The Chicken Tax remains to this day and this is why Ford and Chevy dominate the truck market in the US. It also explains why Toyota and other foreign truck manufacturers have located manufacturing facilities in the US where the tariff can be avoided due to domestic production. It also gave us the Subaru BRAT in 1978 with impossibly impractical back seats that technically made it a car and not a truck.
Subaru BRAT
Steel has long been a popular target for protectionism. Nearly every country views steel as a vital industry and many have enacted policies to promote domestic production. More recently, President George W. Bush raised tariffs on steel to 30% in 2002 and once again there was retaliation. After the WTO deemed the tariffs illegal, several European countries responded with tariffs that directly targeted states that were carried by Bush in the 2000 presidential election. Election interference? Among the many tariffs imposed on the US, taxes on textiles directly hit mills in North Carolina while orange juice tariffs harmed Florida’s agriculture.
Protection from the “dumping” of low-priced goods and other anti-competitive policies is usually the justification for raising tariffs. What makes President Trump’s steel and aluminum tariffs unusual is the argument of national security, which has not really been used since the fall of the Soviet Union. In fact, the four largest sources of US steel imports, Canada, Brazil, South Korea, and Mexico are all US allies. Canada and Mexico have been granted a temporary exemption from the new tariffs but so far they have only been granted 30-day exemptions. We’ve yet to hear from the WTO.
In case you missed it, here is a timeline of tariff action and tough talk so far in 2018:
January 2018—The US announces a 30% tariff on imported solar panels, most of which come from China, and taxes on large residential washing machines starting at 20%. Other affected countries, including South Korea and Mexico, threaten varying degrees of retaliation to the tariffs.
February 2018—The US Commerce Department, led by Commerce Secretary Wilbur Ross, proposed a range of tariffs including 24% on steel and 7.7% on aluminum. China said it will “take necessary measures to defend our rights” if it is hit with tariffs.
March 9, 2018—Trump follows through on the tariffs recommended by his commerce department, taxing steel imports at 25% and imported aluminum at 10%. US neighbors Canada and Mexico are exempted from the tariffs, with Trump saying other countries could potentially receive similar exemptions if they can “ensure that their products no longer threaten our security.”
April 2, 2018—China imposes tariffs on US imports worth $3 billion, including a 15% duty on 120 American products including fruits, nuts, wine and steel pipes and a 25% tax on eight others, including recycled aluminum and pork.
April 3, 2018—US threatens to target another $50 billion in Chinese goods.
April 4, 2018—China warns of tariffs on another $50 billion in American goods.
April 5, 2018—Trump calls for targeting another $100 billion in Chinese goods.
April 13, 2018—Trump tells his advisors to study re-opening talks regarding joining the Trans-Pacific Partnership.
As in past trade spats, some of the announced tariffs are politically targeted. For example, the Chinese tariffs on soybeans, sorghum, and live hogs are designed to directly target Trump’s political base.
On its face it looks like a trade war is heating up. But history has demonstrated that there is much to lose if this escalates. Recent stock market volatility has clearly signaled that this time is no different. Trump’s economic team has thus far soothed investors by explaining that the tough talk and actions so far are part of intense, behind-closed-doors negotiations with China. Hopefully that is true. China accounts for the largest share of US imports from any country. A trade war with China alone will lead to increased prices for many goods in the US over the short term. If Canada and Mexico, our next two largest sources of imports, decide to respond, things could deteriorate rapidly.
The President has repeatedly said he will take a firm stance to protect the competitiveness of US economic interests. Early in his presidency, Trump kept a campaign promise and withdrew from the Trans-Pacific Partnership (TPP), which included China, Japan, Australia, Canada, and Mexico and which would have created the largest economic bloc in the world. The President has made the case that China is the guilty party by correctly pointing out that China has long given government support to industrial and manufacturing development that has allowed Chinese firms to sell goods at lower prices than most competitors. Chinese firms have also been very active in buying competitive advantage in recent years through acquisitions of foreign technology companies. While the WTO is charged with maintaining reciprocity in trade, actually proving that China’s actions are anti-competitive is difficult. President Trump has clearly decided to go it alone. Trump claims he is a great negotiator and that “trade wars are easy to win.” I guess we’re going to find out if he’s right. In the meantime, buckle up for more market volatility.
The information included in this article and the Tax Foundation tax-estimator tool are for informational purposes. Please consult your tax advisor before acting on this information.
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