Thinking About the Tariffs and the Laffer Curve

By James Pethokoukis of AEI.

"At a legendary 1974 Washington dinner, economist Arthur Laffer supposedly sketched his famous curve on a napkin, demonstrating how excessive taxation could reduce government revenue. Now researchers have applied this concept to tariffs, revealing a harsh truth: Even under optimal conditions, additional tariff revenues would peak far short of the amounts claimed by the Trump White House and just a fraction of the $2.4 trillion from federal income taxes. The more successfully tariffs cut imports, the fewer goods remain to tax, making a return to McKinley-era funding economically impossible.

Supply-side conservatives face a striking contradiction: While the famous supply-side theorist Jude Wanniski blamed the Great Depression on an investor freakout over the Smoot-Hawley Tariff Act, today’s supply-siders support President Trump’s tariffs despite negative market reactions. By Wanniski’s logic, these market selloffs should be viewed as rational verdicts on protectionist policies.

This inconsistency in supply-side thinking extends beyond market reactions to tariffs. The Laffer Curve demonstrates that between zero taxation (zero revenue) and 100 percent taxation (also zero revenue) lies a revenue-maximizing rate. When applied to tariffs, however, the analytical device suggests unavoidable and unpleasant trade-offs for Trumponomics supporters: The Trump administration wants tariffs to both reduce the trade deficit and increase revenue—goals that fundamentally conflict. 

A new analysis, “Tariffs cannot fund the government: Evidence from tariff Laffer curves,” undermines the idea that the Trump tariffs could replace federal income taxes.(A bit of basic trade economics: Tariffs don’t directly reduce trade deficits over the long run because these deficits are fundamentally determined by differences in savings and investment between the United States and foreign countries. Tariffs simply reduce overall trade. They cannot permanently alter net exports.)

So to execute this thought experiment, the researchers assume the US trade balance isn’t fixed. From this adjustment flows the finding that the more successful tariffs are at cutting imports, the fewer goods remain to tax. Shrinking imports automatically shrinks the taxable base. When tariff revenues help shrink the trade deficit by 50 cents on the dollar, the study finds, maximum additional revenue drops below $300 billion, enough to fund barely two weeks of federal spending.

From the paper:

In short, the Laffer rationale applied to US trade explains why a return to the McKinley era, when import tariffs used to finance half of US federal spending in the absence of income taxes, is unrealistic. Hiking import tariffs is not a viable solution to fund today’s public finances.

This reality exposes a central contradiction: A trade policy successful at reducing imports—which tariff opponents think is possible—necessarily limits its own revenue potential. For supply-siders who once championed tax reductions to stimulate economic activity, embracing tariffs (essentially tax increases on global commerce) represents a profound departure from their intellectual roots.

As markets continue to react negatively to protectionist policies, perhaps it’s time for a new napkin sketch, one that honestly depicts the limitations of tariffs as revenue instruments in a modern economy."