Five Myths About Tariffs

By Michael Munger.

"We have been hearing a lot about tariffs lately. Some of it is accurate and useful. But not much. Here are five dangerous myths about tariffs.

1.  Tariffs are a “sales tax”

A sales tax is (usually) an ad valorem levy imposed at the point of final sale, and added to the listed price of the item. So, a 5 percent sales tax on a $10 widget means the consumer pays $10.50. In the US, sales taxes are transparent, itemized separately on the receipt. A tariff is imposed when the widget enters the country; the cost is nowhere itemized, and consumers are unaware that a tariff is built into the price they pay. Further, tariffs are often imposed on inputs, not on final products. This raises the costs for manufacturers and producers, but is again not reflected in an itemized receipt as a proportion of the costs.

But tariffs do resemble sales taxes in one way: the tax is usually paid by the consumer and not the producer, depending on the responsiveness of sellers to changes in price. For example, even though the importing wholesaler writes the check to pay the tariff on steel at the port, the actual costs are ultimately almost fully passed on to consumers in the form of price increases in all the products made with that steel.

2.  The higher the tariff, the less it costs

A dialogue, one that has actually happened many times:

Advocate of tariffs: “Low tariffs are good, but high tariffs are even better, because they cost less!”

Me: “How can that be?  Tariffs are an increase in the cost of stuff people want to buy, or in the cost of inputs that producers need to make stuff. Even if you think the benefits of “protection” are large, the cost of tariffs has to be related to the size of tariffs.”

Advocate: “Ah, but if the tariff is high enough, the revenue starts to fall. That means people are paying less, right? And for very high tariffs, there is zero revenue. That means, zero cost!” 

Me: “Look: the cost of tariffs is partly—and for high tariffs, entirely—the artificially high price of products made in the US! There is no necessary relation between the cost of the tariff and the amount of revenue.”

Advocate: “(contemptuous stare, unconvinced)”

The US government could tax people, and then pay subsidies to producers it likes, and whose unions will support them at the ballot box. Tariffs do the same thing, but trade protection “cuts out the middleman”! Instead of the government taxing consumers, and then giving the money to favored producers, the government forces consumers to give an artificial bonus to domestic producers directly, in the form of higher prices caused by foreclosed competition from abroad.

Now, you may think the benefits of such protection are high enough to justify this cost. I disagree, but that’s not the myth I’m dispelling here. The myth is that higher tariffs cost less: in fact, whatever the benefits, higher tariffs cost more, even if amount of the artificial price increase is hard to measure, because consumers don’t realize the higher domestic prices are caused by keeping cheaper foreign products out.

3.  Tariffs raise a “wall of protection” for US producers, and workers

At some level, this claim has to be true, but protection is actually bad: that’s why we have antitrust laws! Capitalism requires market power to be disciplined by competition, or the threat of competition, from other producers or other workers. It is the knowledge that others are trying to make their products better, cheaper, and more convenient that leads to improvements and innovation.

A firm that is protected from competition by contracts in restraint of trade, or by mergers that “protect” their market power and margins, is (quite rightly) subject to legal sanction. But then why is that kind of illegal protection not only allowable, but desirable, in the case of foreign firms? If we want protection, then why don’t we repeal the antitrust laws?

The difference might be that tariffs “keep the profits, and the wages, at home” in the United States, rather than benefiting firms, and workers, in other countries. But a mountain of academic research has shown that the costs of “protecting” domestic market power dwarf the benefits; it’s not even close. The costs to consumers are almost always larger—and may be much larger, three or four times larger—than the profits and wages that are “kept home.” For example, a steel mill job that pays $80,000 that is “protected” by tariffs and trade barriers likely costs consumers and the American economy at least $160,000, and maybe more, in increased prices and reduced innovation and improvements in production processes.

4.  Tariffs are a classic “American System” policy:  Tariffs protect domestic producers, and are paid by foreigners, a win for everyone. In fact, tariffs were once the main source of revenue for the federal government, and can be again, which would “enable the US to get rid of the income tax.” Best of all, “tariffs do not cause inflation,” and so they are not a problem.

Well, where to start. It is true enough that the US federal government was once mostly financed by the tariff, before the income tax was enabled by the Sixteenth Amendment. Before the income tax, tariffs and other taxes imposed on transactions at ports accounted for eighty percent or more of total federal revenues. But in 1900, total federal revenues were less than $20 billion in 2024 dollars! There have been estimates that tariffs today, even assuming no reduction in imports, would raise no more than $250 billion, as a way of financing a federal budget of $6.5 trillion.

It seems like that just requires higher tariffs, but as I discussed earlier the problem with tariffs is that rate increases quickly begin to cause revenue decreases. It’s like the “Laffer Curve,” only more so. To achieve the (dubious) desired objectives of offering protection to domestic industries, the rates would have to be high enough to reduce imports. But that would cut tariff revenues sharply. Using a tariff to increase federal revenues might be defensible, but then one cannot use those same tariffs for protection; it’s logically impossible.

Finally, the claim that tariffs don’t raise the general price level is true enough, but then the whole point of “protection” is to increase the prices of imported goods compared to domestic goods, a relative price change. In a country that depended on imports for almost all its consumer goods, that might look like inflation, but in the US the effect would be to cause people to substitute away from imports.

One might respond that income taxes also have distortionary effects, but as was discussed above the costs of the distortions caused by tariffs are large and permanent, because “protection” insulates industries from the scolding winds of competition. If tariffs were ever part of a valid “American System,” that time has passed.

5.  Tariffs are not a tax at all, but a way to create “a level playing field!” Other countries subsidize their producers, and then “dump” their output at prices below their cost in US markets.

Sweden can grow pineapples, in hothouses (seriously), but it costs a lot of electricity. Better to buy pineapples from someplace with a warmer climate. The US could make all its own socks, but the area of China around Datang (“Sock City”) has developed specialized machines and skilled labor that can produce socks at about half the cost required in the US.

The pineapple example is comparative advantage; the socks example is division of labor. Those two factors tell us why international trade is so useful, and how it creates so much wealth: nations that pursue their comparative advantage specialize in what they do can do at relatively lower cost, and then use the value that creates to exchange for all the other products they need. There is quite a bit more stuff in the world, and everyone is wealthier as a result.

Well, not quite: sock manufacturers in the US, and would-be pineapple-growers in Sweden, have a problem, because their costs are much higher than their competitors in other countries. That brings up the hard-to-define concept of “dumping,” which has two very different meanings:

i.        Country A sells its products in country B below the costs of country A, because A’s producers are subsidized by the government of A

ii.  Country A sells its products in country B below the costs of country B, because A’s producers have a comparative advantage in selling those products.

Situation (i) is certainly possible, and some countries do subsidize some of their industries such as steel, shipbuilding, and agricultural products. Still, if someone gives you a discount, that means you get cheaper products. Dumping, unlike tariffs, really is a levy on the foreign taxpayers who have to pay the subsidies. But you can see why this might upset US producers, because the cost of the products are being kept artificially low.

The problem is that the more common situation, by far, is (ii). It’s upsetting to me when my competitors have lower costs than I have, but the solution can’t be tariffs. The solution is for me to find ways to lower my costs to be competitive, or to reinvest my productive assets into some other business, one where the US does have a comparative advantage. Again, our earlier example makes this clear: Swedish pineapple producers could demand tariffs on those Hawaiian pineapples, with their “unfair” levels of warm climate and sunshine. But the high costs of growing pineapples in Sweden is a sign that those assets should be employed in some other activity.

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The poorly informed arguments for trade protection remind me of the fifth, or twentieth, movies in the Terminator series: you think the monster is dead, but it seemingly can’t be killed, only suppressed until the next bad movie. Given the tightly focused political and economic benefits, targeted on key industries or powerful labor groups, perhaps this is understandable. I have tried to outline five of the most egregious myths, because there is no reason to be taken in by old, debunked claims."