Tariffs Were Never Meant to Transform America
Two of the primary justifications for America imposing tariffs on the world were to onshore manufacturing and replace income taxes. The arguments went something like this:
- Higher tariffs, especially on big exporting countries like China, would incentivize companies to manufacture in the United States; and
- Higher tariffs would generate sufficient revenue to replace income taxes in America, bringing about a new golden age akin to the U.S. economy under President William McKinley at the turn of the 20th century.
Perhaps McKinley’s economy was prosperous for robber barons during America’s infamous Gilded Age, but ordinary workers at the time may have objected to that characterization given the lack of occupational safety standards, labor unions, social safety nets, and basic food safety. Anyone who has read The Jungle by Upton Sinclair knows how unchecked corporate greed and power defined that era in American life.
If the goal was to return to some version of that society, when America was a manufacturing economy without an income tax, America would want to maximize its tariff rates on everyone, whether friend or foe. Individual income taxes account for some 54% of total revenue for the U.S. Federal Government, which for the past few years has been around $2 trillion in annual revenue.
At the tariff rates the Trump administration had imposed on everyone prior to the recent U.S.-China deal, the U.S. government was bringing in around ~$190 million per day from tariffs. At that pace, America would need ~10,526 days to reach the amount of revenue it generates annually from income taxes.
So even before the U.S.-China deal was struck, replacing income taxes with tariffs was never a realistic possibility unless tariff rates were significantly increased across the board, above and beyond the 145% that was previously imposed on China.
This is why I have struggled to understand Trump’s tariff strategy. One day he’s all about tariffs, calling them one of the “most beautiful words” in the English language. On another day he’s using them as punishment against countries like China, Mexico, and Canada for anything from fentanyl to illegal immigration. Then on different days he’s using tariffs to extract concessions, encourage U.S. manufacturing to reshore their production, and defend strategic U.S. industries like semiconductors and defense.
Maybe the real strategy is a combination of all of these goals, but that still begs the question of how the recent U.S.-China trade deal fits into the grand plan. It effectively brings tariff rates against China down to 30%, which is still high for a major trading partner, but reduces fears of the bigger problems — widespread shortages in America and massive job losses in China.
Key questions remain, however, about the overall strategy and plan: How will this new deal incentivize the on-shoring of manufacturing in America? How will it help America generate more revenue from tariffs?
The problem here is that the messaging changes day-to-day and depending on Trump’s audience. It’s unclear how he defines success amidst this uncertainty, unless the prize is attention and the ability to declare victory when some certainty arrives.
The zero-sum world of President Donald Trump
Trump made no secret about his intention to impose tariffs ahead of his second term. He often cited President McKinley. He called for a new “golden age” for America. And he constantly reiterated a promise dating back to 2016 of “we’re going to win so much.”
This is how Trump views the world — America wins, and consequently, others must lose. It’s a zero-sum worldview where the gains of one country must come at the expense of someone else, similar to aligning credits and debits in an accounting ledger. Nowhere was this worldview better illustrated than on Liberation Day when Trump unveiled his tariff board, which was not actually based on reciprocal tariff rates as he said, but was based on trade deficits.
From Trump’s perspective, anyone who was selling more to U.S. consumers, but was not buying an equal amount of goods, must be ripping America off. While there are good arguments for more balanced trade, Trump’s zero-sum perspective counters the prevailing U.S. view for the past 80+ years that free trade can lead to global prosperity. It’s also at odds with the perspective of famous investors like Warren Buffett who have warned that “trade should not be a weapon.”
Nevertheless, Trump is insistent on winning for America, and as with any game, appears to think that others must lose in order for it to happen. The U.S.-China deal is a good example of why this mindset has potentially prevailed over any real effort to transform the U.S. economy by bringing back manufacturing and/or replacing the income tax.
The goal is to appear as winners, not to transform the U.S. economy
Prior to the U.S.-China trade deal, many people across traditional and social media argued that Trump imposing high tariffs on China was part of the “art of the deal.” It was part of a grand strategy to force China to reorient its export-first economy into more of a consumer economy like the United States. High tariffs were going to bring back old-fashioned manufacturing to America and potentially even replace the income tax.
Yet nothing of the sort was agreed to in this latest U.S.-China trade deal. Arguably China’s biggest concession was agreeing to pay an extra 20% tariff for its role in the fentanyl trade. But there was nothing in the deal about China agreeing to purchase more American-made products, build new factories in America, reorient its domestic economy to focus more on consumption, or address its theft of U.S. intellectual property.
The massive drop in the effective tariff rate from 145% to 30% even caught financial markets off-guard. They soared to some of their highest levels since Liberation Day, with the NASDAQ back in bull market territory. Nobody was expecting this degree of a concession from the U.S. on the tariffs it was imposing on China (many had predicted tariffs around 60%).
In the announcement of the deal, there was no mention of bringing back American manufacturing or about replacing income taxes. And the reason for that is simple — neither objective is possible under these new terms.
As I argued in previous essays, 145% tariffs would probably incentivize more American manufacturing and new supply chains, but it likely would take years if not decades. There is also the uncertainty posed by new technologies like artificial intelligence and robotics, which likely will replace many existing manufacturing jobs in China and elsewhere in the near future.
But none of this was at the forefront of the recent U.S.-China deal because tariffs were never meant to transform America. They were always intended as bargaining chips and leverage.
Tariffs are an easy way for the Trump administration to command attention and declare victory
Here’s the strategy:
- Impose tariffs;
- Cause heated negotiations and market volatility;
- Remove or reduce tariffs, returning to a similar state before tariffs were imposed with little to nothing change; and
- Claim victory
To the untrained eye this may look like progress and the art of the deal. But to many small businesses who rely on Chinese supply chains and to investors who own U.S. debt or equities, it looks like uncertainty.
This will have everlasting consequences that transcend the U.S.-China trade deal. While small businesses may reconsider their supply chains in case we revert back to higher tariffs after the deal expires in 90 days and investors may be more skittish to invest in America, the real consequences sit with China. They’ve now witnessed multiple concessions from the Trump administration, first shortly after Liberation Day when markets were free-falling (particularly U.S. Treasuries), and second by agreeing to drastically reduce tariffs in exchange for almost nothing.
China witnessed America’s dependency on its exporting market and importantly its control of rare Earth materials. It reminds me of the leverage Russian President Vladimir Putin knew he had over Europe as their primary supplier of natural gas when he launched his offensive war against Ukraine. It should make the Trump administration and the world unsteady about what this could mean for Taiwan.
What the rest of the world has learned is that America is willing to concede on tariffs in exchange for little. Of course, most countries do not have the bargaining power of China, but they all have one unique ability that could serve Trump well — making him look like a winner.
While the tariff negotiations and uncertainty may be bad for business overall, it can be politically powerful for Trump if he can convince his supporters that progress was made in their interests. Even if he has achieved few concessions, the chaotic activity and market volatility commands media attention and gives the appearance that big things are happening. Even if those big things are more about political theater and less about bringing back American manufacturing or replacing the income tax.
Sometimes appearing like winners is more politically powerful than winning itself.
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