Disruption (Page 3)

Legend has it that the supply-side revolution – Ronald Reagan’s 1981 cut in the US top income tax rate to 40 % from 70 % – began in a Washington restaurant, when economist Arthur Laffer drew his eponymous curve on a cocktail napkin for then White House Deputy Chief of Staff Dick Cheney.

At a tax rate of zero, the state has no duty income, but it also has no income at a tax rate of 100 %, because the business would shut down. Somewhere in between, there’s a revenue price that generates the utmost income.

The US didn’t continue to run trillion-dollar trade imbalances without dire consequences. The US gross foreign investment status has sunk to bad$ 25 trillion, roughly equal to the sum of US imbalances over the past 30 years. During the past decade, foreigners poured into US tech stocks. If the tech boom fades, for example, the US will have to persuade foreigners to buy bonds, and that implies higher interest rates to attract funds.

Tariffs are a tax, and Laffer’s simple illustration applies to the impact of tariffs as well, although more variables are in play. A reasonable guess is that tariffs in the 10 % to 15 % range would yield a meaningful amount of revenue without undue disruption of economic activity.

Tariffs have multiple effects: Domestic production will replace some imports, but some consumers and businesses will have to absorb higher import prices. Some exporters will build plants in the US to avoid tariffs, as US President Trump proposes.

It’s probably impossible to calculate the crosswinds at play. Supply constraints are a big factor, the United States has a skilled labor shortage, as TSMC discovered while building its Arizona chip fabrication plant. The US now imports most of its capital goods, moreover, which means that US manufacturers can’t replace imported goods with made-in-USA alternatives without first importing more machines and production imports.

The Laffer curve represents a common-sense idea, but a powerful one: Too much taxation stifles growth. The location of the maximum point on the curve isn’t self-evident by any means, but it frames the problem handily. I’m one of the original supply-siders, I have written a dozen papers over the years for Laffer’s consulting firm, and between 1988 and 1993 I was chief economist for the consulting firm of the late Jude Wanniski, the publicist who made Laffer famous.

The supply-siders argued that the economic growth generated by tax cuts would more than cover the cost of issuing new government debt to cover a transient shortfall in revenues, back when US government debt was just 30 % of GDP, compared to 125 % today, and the top marginal tax rate was 70 %, vs. 37 % today.

Treasury Secretary Scott Bessent has called the current national debt” a disaster”, with good reason. The US needs new sources of revenue and tariffs are an important part of the policy mix.

A” Laffer curve” for tariffs might look something like the chart above. Unlike the original Laffer curve for personal income tax rates, revenues don’t fall to zero, tariffs are a levy on price, not income. The right side of the curve remains above zero, although a very high tariff is likely to lose revenue as imports disappear and economic activity shrinks.

A 10 % tariff would yield$ 300 billion on America’s$ 3 trillion of goods imports. Some part of that would be paid by foreign exporters rather than American purchasers, either through currency devaluation or lower profit margins. If foreigners pay half ( rough guess ), the price of imports would rise by just 5 %, barely a speed bump.

That$ 300 billion in revenues is real money. If spending cuts generate$ 200 billion in savings and slightly lower interest rates save$ 200 billion in interest costs, the deficit will fall by$ 700 billion, or more than half. That would leave room to extend the 2019 personal income tax cut and avoid higher marginal tax rates that would impair economic growth.

Imports would fall ( as in the red line on the chart ), so a 15 % tariff would produce a smaller increment in revenue, to$ 350 billion. As noted, foreign exporters can bear a great deal of the burden at a 10 % tariff rate. As tariff rates rise, foreigners will pay a lower share. They can only cut profit margins so far or devalue their currencies so much. Devaluation on the part of trading partners, moreover, isn’t what America wants: It makes US goods less competitive and tends to raise the trade deficit.

One study estimates that a 10 % increase in import prices would raise the Producer Price Index by 1 %. A Boston Federal Reserve report published in Feb. 2025 states,” A 25 % tariff on Canada and Mexico combined with a 10 % tariff on China could add 0.5 % to 0.8 % to core PCE inflation”.

A tariff of 15 % or higher would raise costs for US business significantly. US imports of capital goods ( not including autos ) exploded after Covid, rising by nearly 50 % during the Biden administration. The US can restore capital goods manufacturing, but it would have to import capital goods to do so, which means that imports would first have to rise in order to fall in the future.

There are arguable exceptions. The Trump Administration is proposing a 25 % tariff on autos, not because it expects American consumers to pay nearly 25 % more for new cars, but because it wants foreign auto producers to build plants in the United States. The impact of tariffs above the 10%-15 % level is terra incognita for economists. But it is a reasonable assertion that tariffs in the 10%-15 % range will generate significant amounts of new revenue without much damage to economic activity.

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