Years ago, I wrote a short and very simplistic post that can help explain why a country (or for that matter, any group of people) can run a trade deficit with another country (or again, any other group of people) and still grow their welfare (economy, wealth, etc.) faster than the other country. You can find it here. The post makes a number of basic points using a simple example. I’ll also repeat here that, these years later, I’m still not an economist and I’m not otherwise an expert on certain aspects of international trade. However, I am someone who thinks quite a bit about supply chains and thus, given the configuration of the modern global economy, I do think about international trade and transportation and the potential impact of various import tariffs on supply chains.

First, here is an update on the scale of international trade and its role within the US economy. I’ll use official trade statistics provided by the US Census Bureau. If we look at the trade of physical goods which is the first thing that most people think about when it comes to trade, the US imported US$3.112 trillion worth of goods in FY2023. That is simply a lot of stuff. Note that imported goods can be finished products that are distributed (eventually) through various retail channels to end consumers. But they can also be various inputs to production: supplies, components, or work-in-progress inventory that feeds US manufacturing enterprises. A very good example along these lines is Canadian heavy crude oil, shipped to US petroleum refineries as the key input to the production of refined petrochemicals like gasoline, jet fuel, and other products. You can read elsewhere why the US currently imports heavy crude from Canada when it (already) produces more crude oil than it consumes each year and is thus (already) a net exporter.

Most US consumers understand that large parts of our economy rely on imported goods. Fewer might think about the sheer scale of the US goods export economy. Looking again at FY2023, the US exported US$2.051 trillion worth of goods (includng some of that aforementioned US-drilled crude oil). Wow, again, that is a lot of stuff. But it is true that the balance of trade here currently favors imports over exports. Since we import more goods value than we export, we ran a goods trade deficit with the rest of the world of US$1.061 trillion in FY2023.

A large part of the US economy today is the provision of services and not goods. There are all sorts of services: food service, financial services, educational services, transportation services, consulting services, and so on. And the US does trade in services as well, both importing services from foreign providers while exporting services to foreign customers. In fact, the US ran a trade surplus in services of US$288 billion which reduced the overall net trade deficit to US$773 billion in FY2023.

Now let’s discuss tariffs for a bit, and let’s consider duties on imported goods. If the US places a 10% tariff on a bundle of goods (perhaps a specific category of goods from a specific set of countries), then importers of those goods must pay a customs duty on the declared goods before they can be moved into the US (so-called customs-clearing). As many have noted already, these importers-of-record are firms doing business in the US (or individuals) that have arranged for the importation. Examples of such importers include retailers like Walmart and producers like Ford and ExxonMobil. Customs duties collected go into the US Treasury, similar to personal income taxes, social security and Medicare taxes, and corporate income taxes. However, the fraction of US government revenue raised by tariffs has been very small for a long period of time. In FY2023, the total collected customs duties by the US Treasury was about US$80 billion. In fact, FY2023 trade was down a bit from FY2022 when total goods imports were US$3.35 trillion and total collected duties were US$112 billion, or an average duty of about 3.3%.

So, how much revenue could be raised by new tariffs? Let’s imagine a strange world where new US import duties did not distort the economy in any way: the same value of goods is assumed to be imported even though both demand for those goods would likely adjust and the purchasing power of each US$ might increase. If the average duty were increased to 10%, the total revenue produced to the US Treasury in FY2023 would have been US$311 billion. How about a 25% average tariff? Well, of course, US$778 billion. For comparison, the US Treasury received US$2.43 trillion in personal and US$530 billion in corporate income taxes in FY2023, an amount nearly equivalent to a universal 100% tariff on the imported goods value basis for all imported goods. The tiny yellow sliver in the figure below shows how little total customs duty revenue has been collected over time and how little changed it has been compared to other revenue sources.

Like any other tax, a tariff can be useful to governments as they seek to design mechanisms to fund (important) government activities while distorting economic activity to favor or disfavor various groups of people, businesses, investors, industries, nations, regions etc. It’s also safe to say that, like any other tax, it can be difficult to determine how economic activity will be specifically distorted by any specific tariffs. In fact, it may be more difficult with tariffs for a few reasons. The first is that unlike a sales tax, a tariff on imported goods occurs upstream of the point-of-sale. Instead, tariffs create increases in supply chain costs for importers, and the impact of tariffs on consumers depends on what happens as a result of these cost increases.

First, it should be noted that some supply chain cost increases cannot be borne at all and can lead to the elimination of some products in the marketplace. Why? A cost increase can lead a producer to decide that a product cannot be profitably produced and marketed, and this is true even if a replacement supply source with a lower (tariff-inclusive) cost of supply can be identified. A retailer may make a similar decision for an imported product. If producers or retailers continue to keep a product in the market, they could decide to lower its quality in some way or to pass on portions of the cost increase directly to its customers. But the supply chain cost persists; perhaps a different supplier could be identified not subject to the tariff, but if that supplier were already providing the same input at the same quality for a lower price they would be used already. Since profitability is likely to be impacted, owners and investors as well as employees of the importer will also likely to be impacted. These interactions are all naturally somewhat complex and the outcome is difficult to predict.

I’ll finish with a thought. If a government wishes to use new tariffs to yield a political outcome beyond simply raising revenue, they will likely need to be designed to produce a significant (and noticeable) distortion to some portion of the economy. If the distortion is mild, no change of behavior seems likely to occur. It seems as if the US is about to attempt some new experimentation with tariffs to both influence the behavior of trade partner nations and to create a significant government revenue source. We will likely get to see firsthand what kind of economic distortion they induce.