The Truth About Tariffs

Summer has arrived and life here in Salem, as the harbor completes its annual refilling of boats on moorings, is good.

On the investing front, after a rough March and April, May felt pretty good by comparison. The stock market recovered its previous levels more or less, which is nice.

We may never know the extent to which some members of Washington’s inner circles profited from inside information about the events that drove sharp dips and spikes. In the grand scheme of the investing world, the particulars aren’t vitally important.

But the U.S. markets are strong and our currency, equities, and bonds are the world’s safe refuge because of our strong rules, and the rule of law. Everything that undermines the reality, or perception, of that rule of law erodes our global positioning. Economists will spend years studying this so we will likely know eventually what the costs, if any, will be to our little experiment.

That is not what I want to discuss today.

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We’ll be talking tariffs. In case you missed it, tariffs have been in the news in recent years as our President seems to be taken with them as both a source of revenue and a point of leverage in international negotiations.

Never more so than in 2025, as President Trump introduced the idea of across-the-board tariffs on goods from nearly every country. The administration was dealt a setback by a trade court last week, being told tariffs are the exclusive purview of Congress with only very limited and short-term exceptions. Not many of us think that will be the final word on tariffs, however, so expect to continue to hear about them, and the threat of them, for the foreseeable future.

While we have been hearing a lot about tariffs, there is clearly a lot of confusion about what they are, how they work, who pays them, and their effect on the global economy and stock market.

So I thought it would be worth a bit of time to make sure we all understand what tariffs are, how they work, and what they affect.

Let’s start with the basics: What is a tariff?

A tariff is a tax imposed by a government on goods imported from other countries. The importer pays this tax to the government. Note that the originating country or industry does not pay the tariff, despite insistence to the contrary by some.

Tariffs are designed to make imported goods more expensive, thereby encouraging consumers to buy domestic products or discourage purchase of imported goods instead.

In the early years of the United States, tariffs were the primary source of revenue for the Federal government. The tariffs had the effect of discouraging sending limited wealth out of the country and encouraging domestic production of goods.

But, relying on tariffs has some real limitations and inequities:

Economic Distortion

· Tariffs are taxes on imported goods, making many imported items more expensive for consumers.

· Protected domestic industries but raised costs for everyday Americans.

· Effectively a sales tax, the impact of tariffs fell disproportionately on the poor and middle class.

Unstable Revenue Source

· Tariff revenues fluctuated with trade volumes and economic cycles. During downturns or wars, imports dropped and so did government revenue.

Regional Disparities

· The South and West opposed tariffs because they imported more goods and felt economically disadvantaged, while the North (especially industrial areas) benefited from protectionism.

· This led to sectional tensions, especially before and after the Civil War.

The Civil War greatly increased federal expenditures, underscoring the need for a more reliable and scalable source of revenue. After some political, legislative and judicial back-and-forth the 16^th amendment to the Constitution was ratified in 1913, enabling a national income tax.

How Tariffs Work

When goods cross a border into a country, the party importing the goods pays the tariff to customs authorities.

Importers may choose to absorb the additional cost. Or the importers or retailers may have no choice but to absorb the costs if they are in a competitive market, particularly if buyers have alternatives that are not subject to tariffs.

Where possible, most importers and retailers will pass all or much of the cost along to consumers through higher prices. For this reason, imposition of broad tariffs tends to drive inflationary pressure.

Tariffs generate revenue for the government, although in modern times, most governments do not generate a substantial share of revenue from tariffs. In estimating tariff revenue it is important to consider the impact of the tariff on prices as well as demand.

Example 1:
The U.S. imports $100,000 of wine that sells at retail for $20. A 5% tariff would increase the cost of each bottle to $21. That probably wouldn’t significantly alter the demand for that wine so the government would likely expect $5,000 in tariff revenue. If instead the government imposed a 100% tariff, causing the retail price of the wine to go to $40 per bottle, consumers might choose a domestic wine, beer, whiskey, hard seltzer or some other alternative. Sales of the imported wine would fall to zero and the tariff revenue would also be zero.

Example 2:
An imported luxury handbag sells for $10,000 and the company sells $2 million worth annually (200 units). The government imposes a 50% tariff, causing the price to increase to $15,000. The buyers of these bags are not highly price sensitive and sales decrease by just 5%, down to 190 units, or $1.8 million. The 50% tariff would raise $900,000.

Why Governments Use Tariffs

As I mentioned above, historically tariffs were a major source of government revenue. Today they play a minor role in most developed countries. The diminished importance of tariffs as a source of revenue is the result of a number of factors.

In modern times, there are a few reasons tariffs are still used.

Protecting domestic industries is a very common reason. By making imports more expensive, tariffs help local industries compete. This can be important when a country has a fledgling industry trying to get established in the face of competition from other countries’ existing industries, particularly where developing nations go up against tier one countries.

Another use of tariffs that has been in the news recently is for retaliation or negotiation purposes. Tariffs can be used to counter unfair trade practices or as leverage in trade disputes. Such uses are fraught and when unsuccessful can escalate trade wars.

The other major reason governments employ tariffs is national security. If a country determines it is important to have a viable domestic industry, tariffs may be imposed to protect them. Industries such as steel, transportation (railroads, airlines), and certain technologies are prime candidates. In many Asian countries, domestic rice production is considered a national priority to ensure the dietary staple is not held hostage by an external supplier perhaps causing enormous disruption and social unrest.

Economic Impact of Tariffs

Tariffs reduce the openness of economies and disrupt global trade flows, especially in sectors with complex supply chains. For example, a major tariff increase can shrink global trade flows by 5.5% to 8.5%, with sectors like transport equipment and electronics hit hardest. There has been a lot of talk about tariffs and how they affect the automotive industry which may incorporate parts for various subassemblies from one country getting assembled in other countries, and these subassemblies are then shipped to yet another country for final assembly.

Tariffs can lead to imports from targeted countries collapsing and some trade shifting to countries not subject to tariffs. Decades of moving production to areas of relative advantage have made supply chains global and complex. Introducing tariffs can have a destabilizing effect on an industry and all of the subsidiary industries that supply it.

As a tax, tariffs increase the cost of inputs into a production process.

For instance, tariffs on imported materials and machinery raise production costs for domestic manufacturers. These costs may be passed on to consumers, or absorbed by businesses, reducing profit margins which will reduce profits or reduce funds for R&D and innovation, wages, or hiring. Higher input costs can also make domestic products less competitive, both at home and abroad.

Thus, tariffs raise prices and reduce the quantity of goods and services available, leading to lower economic output and income. This can produce a domino effect as production costs rise and output falls, lowering wages and hours worked. This adds to the burden, already noted, that the effect of tariffs often falls more heavily on lower- and middle-income households, as they spend a higher share of their income on affected goods.

In the short run, tariffs can generate significant revenue. For example, a hypothetical 10% universal tariff in the U.S. is estimated to raise between $1.4 trillion and $1.7 trillion over a decade, depending on foreign retaliation and economic feedback. This is because it is difficult to change supply chains in the near term, building factories and hiring and training a workforce takes time, and process or product innovations also take time, often leaving businesses little choice but to continue to purchase the resources made more expensive by tariffs.

As tariffs reduce trade and economic activity, the tax base shrinks, and revenue gains are offset by lower income and other tax receipts. The reduced economic activity also has a direct effect reducing demand which reduces tariff revenue over time as well. A double whammy.

Tariffs and Trade Barriers vs. Free Trade

The overwhelming consensus among economists and recent empirical evidence is that free trade is better for the U.S. (and indeed the global) economy than global trade barriers and tariffs. Trade barriers raise prices, reduce economic output, and harm consumers and workers, while free trade promotes growth, efficiency, innovation, and consumer welfare.

The economic impact of trade barriers and tariffs include:

Reduced GDP and Economic Growth
Recent analyses of U.S. tariff policies in 2025 show that broad-based tariffs, especially when met with foreign retaliation, lower U.S. real GDP growth by 1.1 percentage points in a single year and leave the economy persistently 0.6% smaller in the long run – equivalent to a $170-$180 billion annual loss^[10][11][12]. Some models project even larger long-term declines, with one estimating a 6% reduction in GDP and a 5% drop in wages^[13].

Higher Consumer Prices and Lower Household Welfare
Tariffs directly raise the prices of imported goods. The average U.S. household faces a loss of $3,800–$4,900 per year due to higher prices, with lower-income families hit hardest^[10][11][12]. Prices for specific goods like apparel and footwear have risen by as much as 65%-87% in the short run^[12].

Job Losses and Lower Employment
Tariffs increase costs for U.S. producers reliant on imported inputs, leading to job losses in affected industries. While some protected sectors may see modest job gains, these are outweighed by broader losses across the economy^[14].

Global Spillovers and Retaliation
Trade barriers often provoke retaliation from other countries, further reducing U.S. exports and global economic activity. For example, U.S. exports are projected to fall by 16% under current tariff regimes, and global GDP could decline by as much as 1%^[15][12].

Past episodes, such as the tariffs imposed in 2018–19, resulted in net losses for the U.S. economy, including higher consumer prices, disrupted supply chains, and a net reduction in employment^[14]. The anticipated boost to domestic production was modest, as many firms shifted supply chains abroad rather than bringing jobs back to the U.S.^[14].

The economic impact of free trade includes:

Lower Prices and Greater Consumer Choice
Free trade provides access to higher-quality, lower-priced goods, easing inflationary pressures and increasing Americans’ purchasing power^[16][17]. For every 1% increase in market share by imports from low-income countries, U.S. prices are held down by more than 2%^[16].

Economic Growth and Efficiency
By allowing resources to flow to their most productive uses, free trade boosts economic efficiency, drives innovation, and enables higher wages and investment^[16][17]. It also encourages competition, which is vital for long-term economic growth^[16].

Higher Productivity and Living Standards
Trade enables specialization according to comparative advantage, increasing productivity and raising the standard of living for most Americans^[17].

Fairness and Rules-Based Systems
Free trade, when governed by transparent rules, reduces opportunities for cronyism and ensures a level playing field for businesses^[16]. This inspires confidence in the system among business leaders encouraging greater investment in capital expenditures and hiring. The resulting stability also creates an environment where banks and other sources of capital feel more confident making investments, which in turn increases innovation and economic activity generally.

Free trade does come with a cost.

While capital is highly liquid and can easily flow to areas of greatest relative advantage, people are not as fluid. Workers (and their families) whose jobs are displaced may not want or be able to relocate, and may not have the requisite skills for the jobs now available where they are.

So, while there is a broad consensus among economists that free trade creates a stronger economy and better standard of living, an ideal economy would divert a portion of the increased value created by free trade to relocate and retrain affected workers.

Ignoring that need has resulted in higher unemployment and healthcare costs, reduced tax revenues, and greater social unrest, and in many cases given a bad name to free trade in spite of the many benefits it has delivered.

Free Trade vs. Trade Barriers & Tariffs

Tariffs are powerful tools that can protect domestic industries and generate government revenue, but they come with significant economic costs. They raise prices for consumers and businesses, disrupt global trade, and can ultimately reduce economic growth and employment. While they may offer short-term benefits for certain sectors or as negotiating tools, the broad consensus among economists is that tariffs are self-defeating in the long run, with the costs often outweighing the benefits^[1][7][3].

Free trade is consistently shown to be better for the U.S. economy than global trade barriers and tariffs. Free trade increases prosperity, drives innovation, and raises living standards for most Americans^{[16][18][17][12]}.

While some industries may benefit from protection, the overall economic cost is significantly higher than any targeted gains. Even if we completely revert to the conditions before President Trump’s so-called “Liberation Day” we have shaken confidence in the reliability of the U.S. as a stable global leader and won’t know the full repercussions of that for many years to come.

That’s the lesson for today. Everything you ever wanted to know about tariffs. As the recently deceased TV star Ruth Buzzy was fond of saying on Laugh In, “and that’s the truth!”

I wish you a delightful summer of family, friends, travel – and good investing.

Ed Coburn
President, Cabot Wealth Network

References
1. Annual US Tariff Revenue (Dynamic Estimate, 10% Universal Tariff)

2. https://www.statista.com/statistics/217526/revenues-from-customs-duty-and-forecast-in-the-us/

3. https://taxfoundation.org/research/all/federal/universal-tariff-revenue-estimates/

4. https://fred.stlouisfed.org/series/B235RC1Q027SBEA

5. https://taxfoundation.org/research/all/federal/trump-tariffs-trade-war/

6. https://en.wikipedia.org/wiki/Tariff

7. https://www.cfr.org/backgrounder/what-are-tariffs

8. https://cepr.org/voxeu/columns/roaring-tariffs-global-impact-2025-us-trade-war

9. https://www.bbc.com/news/articles/cn93e12rypgo

10. https://budgetlab.yale.edu/research/fiscal-and-economic-effects-revised-april-9-tariffs

11. https://budgetlab.yale.edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffs-enacted-2025-through-april

12. https://budgetlab.yale.edu/research/state-us-tariffs-april-15-2025

13. https://budgetmodel.wharton.upenn.edu/issues/2025/4/10/economic-effects-of-president-trumps-tariffs

14. https://www.richmondfed.org/publications/research/economic_brief/2025/eb_25-12

15. https://www.jpmorgan.com/insights/global-research/current-events/us-tariffs

16. https://www.mercatus.org/research/policy-briefs/benefits-free-trade-addressing-key-myths

17. https://taxfoundation.org/research/all/federal/impact-of-tariffs-free-trade/

18. https://taxfoundation.org/research/all/federal/trump-tariffs-trade-war/

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