Are Trump's Tariffs the New Free Lunch?
Echoes of the Laffer Curve
I originally wrote the column below for publication elsewhere. That didn’t wind up working out, and after pitching it to a handful of other places I decided the better part of valor was to publish it myself while it is still relevant in a pre-election context.
I suspect, though, that it will continue to be relevant after the election regardless of who wins in November. America’s political economy is reorienting itself away from the presumption in favor of free trade, and while I think there are both good reasons for that and bad but understandable reasons for it, the change is going to open up a whole box of new temptations, one of which Trump is pioneering. I doubt he’ll be a last to succumb.
In his first run for president, Donald Trump not only promised to build a wall on the southern border to stop unauthorized migration, but promised that it wouldn’t cost Americans anything because Mexico would pay for it. That free lunch failed to materialize, but now Trump is running on a new one: across-the-board tariffs, which Trump promises will rebuild American industry at no cost to consumers.
Trump’s gambit is a surprising new version of an old Republican song. Back in 1974, economist Arthur Laffer drew a picture on a napkin that arguably changed history by suggesting that tax cuts could, under the right circumstances, more than pay for themselves because of the economic growth they unleashed. Trump’s new free lunch involves tax hikes on imported goods as well as blizzard of tax cuts on everything from corporate profits to tips and overtime. But the illusory promise of a government Americans won’t have to pay for is the same, and could prove just as politically potent—and destructive.
The “Laffer Curve” describes a real phenomenon; at extremely high rates, raising taxes further is counterproductive, and even at lower rates economists need to assess the impact of taxes on economic activity to properly estimate the effect on receipts. But in the hands of the GOP, it became an argument against fiscal responsibility as such. Far from growing, tax receipts fell—and deficits ballooned. The economy boomed in the 1980s, but presidents George H. W. Bush and Bill Clinton ultimately had to raise tax rates and cut spending to bring the federal budget back into balance. The lunch may have been worth paying for, but it wasn’t free.
That contrary evidence didn’t dent the pitch’s appeal, though. When George W. Bush became president, he pushed through his own package of tax cuts which greatly increased the deficit, but their effect on economic growth was negligible. And in the 2010s, Governor Sam Brownback of Kansas implemented a radical experiment in tax cutting that so devastated the state that even the Republican legislature was forced to reverse course. Yet even today, the idea of raising tax rates is political death for a Republican.
Trump’s tariff plan aims to give Republicans the free lunch they still demand. He has repeatedly called for leveling tariffs as high as 20% on all imports across the board, with even higher rates on imports from China, America’s third-largest trading partner, and the source of the largest share of America’s imports. Economists overwhelmingly argue that such a tax hike would make America’s economy less efficient and competitive, and raise prices sharply for consumers.
But Trump describes his tariff proposal in very different terms. The cost won’t be paid by Americans, he says; it will be paid by foreigners, and will thereby generate revenue at no cost to the American consumer. He speaks of tariffs like an entry fee to an exclusive club, as if access to the American market were so valuable that foreign governments would pay virtually any price to achieve it, and American taxpayers could reap the benefit.
There’s a germ of truth in this conception of trade relations. China, for example, leverages the enormous size of its market to force foreign corporations to transfer technology as a condition of letting them invest there, then uses that technology to help build up its own companies into formidable competitors. In the 1980s, to protect America’s auto industry, the Reagan Administration imposed limits on imports of Japanese cars; since they wanted to continue to access America’s huge market, Toyota and Honda invested in auto plants in America—primarily in right-to-work states in the South rather than in Detroit—to maintain that access. And more recently, the Biden Administration has restricted imports of Chinese electric vehicles and subsidized the construction of advanced semiconductor foundries on American soil, both efforts to nurture domestic industries deemed vital for both our national security and our economic future.
These, though, are discrete applications of leverage to achieve strategic policy aims. Those aims can be debated as can the methods used to achieve them, but there is a clear relationship between ends and means. Moreover, they are not a free lunch. There’s a real cost to consumers in limiting access to cheap electric vehicles and and clear budgetary cost to subsidizing semiconductor factories. The price may well be worth paying, but it isn’t free.
An across-the-board tariff, by contrast, is simply a broad-based tax on trade, and as Arthur Laffer illustrated, when you tax something you get less of it. How does less trade help American consumers get more value for their dollar—or help American business become more competitive?
Senator J.D. Vance, Trump’s running mate, has argued that Americans will benefit because new American producers will replace foreign trade. But if Americans bought fewer clothes from the Dominican Republic and Bangladesh, and domestic producers had to fill the gap, how would that benefit Americans? If wages were set at prevailing American levels, then the price of clothing would skyrocket. If the government was determined to keep prices from rising, then wages would have to fall to Dominican or Bangladeshi levels. Innovation could help square that circle, but the know-how to innovate is also a scarce resource. Is the best use of American engineering talent figuring out how to fully automate the manufacture of t-shirts?
In addition to the direct economic costs, there are the costs to political economy. Once tariffs are in place, domestic producers who depend on components produced abroad will have a powerful incentive to lobby for exemptions to across-the-board tariffs. Needless to say, the companies best positioned to acquire such exemptions are the ones with the best political connections. Protectionism always risks providing more protection for strong claimants rather than strong claims, with the end result being a more politicized economy that benefits insiders.
That seems like a peculiar outcome for a populist to aim for—and one unlikely to be popular. But there’s a real risk that precisely because it can be sold as a free lunch, a general turn to protectionism could have lasting political appeal. Trump pairs his tariff hikes with tax cuts so that voters will see him as taking money from foreign countries to put in their pockets. If inflation continues to cool due to relatively high interest rates, unemployment remains low, and profits are robust under the shelter of protectionism, many Americans might find the result congenial. And once they are in place, cutting tariffs could prove politically difficult, threatening as it would be to businesses who had gotten used to the cushion of protection.
That cushion points to the most important long-term cost of higher broad-based tariffs: a reduction in national competitiveness and in overall GDP. Free trade is often blamed for hollowing out America’s economy, but American businesses remain among the most competitive in the world in a wide variety of sectors, and free trade has been vital to their global position. Where we have allowed strategic manufacturing sectors to atrophy, it may be necessary to bolster them, perhaps including through protectionist means—but with the goal of becoming internationally competitive once more, not of retreating from trade.
But most people measure their personal well-being against that of their near neighbors, not against people on other continents. America’s economy has outpaced virtually every developed country competitor in the post-Covid period, but Americans aren’t feeling triumphant because for two years their inflation-adjusted after-tax income stagnated or even decreased. So if America as a whole became a bit poorer and less competitive, but most Americans felt like their economic position got a bit more secure, that might feel like a positive outcome, one they would vote to continue until it’s too late to rebuild our competitive edge.
The danger, in other words, is precisely that the lunch will seem free for just long enough that when the bill finally comes due, we can no longer afford to pay it.