Let’s consider the argument step by step. First, is a trade deficit with a particular country bad? No. One of the easiest ways to see that is to look at your own spending on other producers’ goods. Consider mine. Our household spends over $5,000 a year on groceries from Safeway. But those scoundrels at Safeway spend nothing on my output. If you’re employed, your employer has a trade surplus with you. He or she spends much more on your services than you spend on his products. But that’s not a problem.
The same reasoning applies to a specific country. Our trade deficit with Canada in 2024 was about $36 billion, not the $100 billion that President Trump seems to have pulled out of thin air. And contrary to Trump’s belief, the fact that we spend more on imports from Canada than Canadians spend on our exports does not mean that we’re subsidizing Canadians, any more than I’m subsidizing Safeway. There’s no reason that we should have a zero trade deficit with a particular country. In 2024, the United States had trade surpluses with the Netherlands ($56 billion), Hong Kong ($22 billion), Australia ($18 billion), and the United Kingdom ($12 billion). Was that a problem for those countries? The heads of those countries and, apparently, many of their citizens, don’t seem to think so. It’s very much like you having a trade surplus with your employer.
How about the fact that the United States has an overall trade deficit with the rest of the world in general? In 2024, we exported $3.19 trillion in goods and services and imported $4.11 trillion in goods and services, for an overall trade deficit of $0.92 trillion. What happened to that $0.92 trillion? Did people in other countries keep those dollars? It would have been great if they had. Our government spends less than 10 cents printing a Benjamin. And in return for each $100 we got $100 in goods and services. I’ll take that deal any day. Actually, though, the vast majority of the money came back to the United States in the form of investment. Foreigners used it to buy US government bonds, to buy land and plant and equipment, and to invest directly. The United States, for all its problems, is still seen by much of the world as a haven for investors. Note the irony. On the one hand, Trump is happy that many foreigners are investing in the United States. On the other hand, he’s upset that we have such a large trade deficit. Mathematics is not optional: the trade deficit and the capital surplus are the mirror images of each other.
The above is from my latest Hoover article, “Clearing The Air On Tariffs And Trade Deficits,” Defining Ideas, April 24, 2025.
And:
On April 2, in a Rose Garden speech, President Trump finally unveiled his plan to impose “reciprocal tariffs” on imports from other countries.
The chart he presented, though, was not based on the tariffs those countries were charging. Instead, it was based on an equation that nowhere included the tariff rates charged by governments of other countries. While Trump listed all the countries he wanted to impose higher tariffs on, he neglected to mention that the tariff rates charged by forty-four countries are lower than the average that the United States imposed before Trump’s increases. Most of these countries, admittedly, are small, but they include Canada, France, Germany, Italy, and Japan. Trump did not announce a cut in tariff rates to these countries, thus putting the lie to his claim that he wanted reciprocal tariffs.
But put all that aside. Imagine, contrary to the data, that every country’s government in the world imposes higher tariffs on our exports than the US government imposes on our imports. What would be the best strategy for our government?
The answer may shock you, but I assure you that my answer is based on decades, nay centuries, of economic reasoning and evidence. The answer is: cut our tariffs to zero.
Why? It’s true that when a foreign government imposes tariffs on our exports, it hurts our producers. It also hurts the foreign government’s consumers. If our government responds by imposing tariffs on imports from that country, it helps our producers who compete with those products but hurts our buyers of those items. Those buyers include not just ultimate consumers, but also producers who use the tariffed items as inputs. It’s relatively easy to show, although you need a graph of supply and demand, that the losses to our consumers exceed the gains to our producers.
The bottom line, therefore, is that whatever the other country’s government does, our government’s best option, if it puts the same weight on losses to consumers as it puts on gains to producers, is to have zero tariffs.
And finally:
Two major figures in the last century used metaphors to make the point. One was President Reagan. In the early 1980s, he argued that if you’re in a lifeboat and someone shoots a hole in the boat, it’s not a good idea to shoot another hole in the boat. Yes, you’ll hurt the first shooter; but you’ll also hurt yourself.
The other was famous British economist Joan Robinson. If someone in another country to which you ship goods puts rocks in the harbor to make shipping more difficult, she asked, does it make sense for you to put rocks in your harbor?
At the end I give two plausible arguments for tariffs. The second one is one that I haven’t seen anyone using and I suggest why.
Read the whole thing.
READER COMMENTS
Mactoul
Apr 26 2025 at 3:12am
Your second point is plausible indeed and I supposed recognized in the 10 percent flat tarriff imposed recently.
The whole kerfuffle on trade deficits is an unfortunate consequence of the urge to measure everything measurable or not that the bureaucracies are afflicted with.
If trade is between individuals only, then why even measure imports to and from all countries?
What good that it does?
Jon Murphy
Apr 26 2025 at 8:07am
I don’t think it is. First, the 10% is a floor, not the actual rate. The actual rates are significantly higher. And they are not flat.
Second, the tariff would need to be connected to lower taxes elsewhere, otherwise it’s just a tax increase. There haven’t been lower taxes elsewhere.
So, no, it’s quite improbable that these taxes are part of some optimal tax policy.
Warren Platts
Apr 26 2025 at 11:31am
Um, you of course know that we are running a $2 trillion per year fiscal deficit, right? We probably should do something about it. I’m not sure that telling little old ladies barely scraping by on their $800/month Social Security check that they need to take a $200/month pay cut is the answer. Therefore, taxes may well need to be raised. See my post below: since we’re already charging a 21% corporate income tax, it’s only fair that we charge a 21% sales tax on imported goods. We will be importing $3.3 TRILLION in goods this year. A 21% tariff could potentially raise $700 billion. Not enough to close the gap, but it would put a dent in it at least. (Yes, I know, the amount of imports will likely decline, so we’ll only raise $600 billion. The argument still stands.)
Mike Hammock
Apr 26 2025 at 2:27pm
If the argument is that we need tax revenue to reduce the budget deficit, why only tax imported goods? Why not a general sales tax on all goods, foreign and domestic?
Warren Platts
Apr 27 2025 at 9:10am
We already are taxing goods produced in the United States via the 21% corporate income tax. Note this applies to both OEMs (Original Equipment Manufacturers that supply intermediate parts) and producers of finished goods. Thus, all a tariff does is level the playing field. See my post below.
Warren Platts
Apr 26 2025 at 11:14am
I read the whole thing. The strategic argument for tariffs is only common sense. Your second justification: that tariffs are no different than other taxes and might well fit in some sort of overall revenue raising scheme. That is a bit of refreshing fresh air. I’ve never understood why tariffs per se are the worst form of taxation. It seems to me that the main gripe is that tariffs are somehow unfair wherease other taxes are not unfair, or at least not as unfair. Take corporate income taxes. I think they are still 21%. That’s a tax on demestic consumption, the cost of which gets passed on to consumers. And if Ford orders parts from an American supplier, that supplier still has to pay the corporate income tax. So virtually all arguments one can make against tariffs, one can make against the corporate income tax. Indeed if one is concerned about “fairness,” I would say the current setup is highly unfair: if you tax something, you get less of it; if you don’t tax something you get more of it. Thus, when we tax home producers but allow foreign production to be imported tax free, we are in effect punishing our own producers while subsidizing foreign producers. Therefore, if fairness is a valid concern, then we should have a 21% across-the-board ad valorum tariff on all imports. Adam Smith himself addressed this very issue:
TMC
Apr 26 2025 at 12:46pm
Your two plausible arguments for tariffs are quite good. I’ve been asking about dead weight losses for a while and few people want to acknowledge the point.
As for national security in the broader sense, not just defense, I’d like to make the point that we don’t need to raise tariffs to the point it brings the supply chain back to the US. Raising them to spread our supply chain around the globe better would be cheaper and just as effective. Our concern that China is manufacturing too many things that we require is mitigated if South America or some other region is also a source of goods we need.
Companies diversify their sources in case one company has issues or a region has a natural disaster. We have to incorporate this thinking into economic policy. Todays free trading argument rightly states that free trade is the most efficient policy, but it neglects having a robust supply chain. We have to plan for this robustness, and that does have an efficiency cost. Part of this is making sure our alternate sources don’t rely on China for their materials, or are just fronting China selling us goods.
Jon Murphy
Apr 26 2025 at 1:35pm
Let us assume for the moment that there is some sort of stragety behind these tariffs. It seems to me that, as part of an optimal tax regime, it would not include tariff increases. Your discussion reminded me of Peter Diamond and James Mirrless’s 1971 AER paper Optimal Taxation and Public Production I: Production Efficiency. In it, they argue against any tax that inhibits production efficiency. Specifically, with regard to international trade, they write (pgs 25-26):
Since the vast majority of goods imported into the United States are intermediate goods, should not the optimal tariff be closer to 0% in an optimal tax regime?
Warren Platts
Apr 27 2025 at 9:31am
What about American OEMs? They supply intermediate parts to American manufacturers of finished goods. Yet they still have to pay the 21% corporate income tax. To be consistent, if we’re going to zero tariffs on imported foreign goods, shouldn’t we reduce the corporate income tax on OEMs to zero as well?
Jon Murphy
Apr 27 2025 at 9:41am
OEMs pay the coprorate income tax, too. I fail to see how it’s “consistent” to slap another tax, upwards of 100%, on them.
Regardless, it’s irrelevant to my point.
Warren Platts
Apr 27 2025 at 10:22am
That’s what I just said: that American OEMs that supply U.S. manufacturers of finished goods have to pay the 21% U.S. corporate income tax (which is of course a tax on consumers, ultimately, just like tariffs). However, I’m pretty sure that Chinese OEMs that supply American producers of finished goods DO NOT have to pay the 21% U.S. corporate income tax. Correct me if I’m wrong. So, to be consistent, if we’re going to tax U.S. intermediate goods, then we should tax imported intermediate goods. Either that, or, alternatively, stop taxing U.S. producers of intermediate goods. Under the pre-Trump regime, U.S. producers of intermediate goods were punished, whereas imported intermediate goods were let into the country virtually tariff-free. That’s not only unfair, it doesn’t even make sense. See the Adam Smith quote above.
Jon Murphy
Apr 27 2025 at 11:31am
Anyone who sells into the US pays US corporate income tax; it shows up in the consumer prices. The only way to avoid it is to not do any business with Americans at all.
Craig
Apr 27 2025 at 11:43am
“Anyone who sells into the US pays US corporate income tax; it shows up in the consumer prices. The only way to avoid it is to not do any business with Americans at all.”
No, that is not true, I buy things from many suppliers, many of which are foreign based and no, they will NOT have to file US corporate or income tax returns of any kind. Income taxes generally follow territoriality rules based on where the income is earned. So if I buy something from Italy, I might pay a tariff, I can deduct the cost of that item off of my taxes as a legitimate business expense, but the Italian manufacturer does not become subject to US taxation there, the Italian manufacturer will be subject to Italian income tax and will typically get some kind of exemption for VAT. Of course if I sell the item to you at a markup, that is now profit and I have to pay income tax on the profit because I am based in FL. Selling ‘into’ does not satisfy what are typically thought of as ‘minimum’ contacts or ‘purposeful availment’ of the jurisdiction.
Craig
Apr 27 2025 at 11:45am
“That’s what I just said: that American OEMs that supply U.S. manufacturers of finished goods have to pay the 21% U.S. corporate income tax (which is of course a tax on consumers, ultimately, just like tariffs)”
Well, not quite, the taxes ARE different. One is a tax on the gross sale as the item crosses the border (which obviously might be a wholesale transaction of course), and the other is a tax on the residual…..so you will pay the tariff even if your business is losing money, but if you’re business is losing money you will not pay income tax.
Jon Murphy
Apr 27 2025 at 7:13pm
It is true, Craig. Unless you’re buying directly from the supplier who handles their own shipping and brings it right to your door, corporate income tax is being paid.
Warren Platts
Apr 28 2025 at 10:36am
No, Craig is right. If Ford orders a part from Italy, the producer of that part does not pay U.S. corporate income tax. Ford does, but the foreign producer of the intermediate good does not. If there is an American OEM across town from the Ford plant that manufactures an identical part, THAT producer of intermediate goods does indeed have to pay US corporate tax. And actually it’s worse than that: American producers of exports have to pay US corporate tax, whereas exporters in Italy are not only exempt from US corporate income tax and they come in tariff-free, they also get the Italian VAT completely refunded! And since Adam Smith is the second coming of Jesus, then we should take him seriously when he says, “It will generally be advantageous to lay some burden upon foreign industry for the encouragement of domestic industry, when some tax is imposed at home upon the produce of the latter. In this case, it seems reasonable that an equal tax should be imposed upon the like produce of the former. “
Craig
Apr 28 2025 at 10:36pm
“Unless you’re buying directly from the supplier ”
Even in the case of a multinational, while we think of a multinational as a monolithic entity, the US entity and the foreign entity are actually separate legal entities, albeit related entities. The foreign supplier simply does not pay corporate income taxes in the US because it isn’t present here.
“who handles their own shipping and brings it right to your door, corporate income tax is being paid.”
If the foreign entity actually DID handle their own shipping and brought it themselves to my door then that entity is PRESENT here and they then WOULD pay taxes here. Of course what’s common is they use some 3rd party common carrier. Terms would be FOB Factory or CIF but in either case the factory does give the item to the shipping company and FOB/CIF really only relates to who is paying for the shipping and ‘risk of loss’ neither of which are pertinent for giving rise to minimum contacts for purpose of paying corporate income tax.
Roger McKinney
Apr 26 2025 at 8:14pm
What would happen to a trade deficit under a gold standard? Gold would leave. With less reserves, interest rates rise and slow the economy. Eventually the deficit reverses. So, trade deficits don’t matter. Things are different without gold.
Today, the federal deficit drives the trade deficit because Americans don’t save enough to finance it. Only foreigners save enough. But they need dollars. They get dollars to buy federal debt by selling us stuff.
Jon Murphy
Apr 26 2025 at 8:49pm
I have a blog post coming out on this. I don’t think it’s true the federal deficit is driving the trade deficit. Foreigners have been moving away from buying government debt, preferring more corporate debt and equity.
Warren Platts
Apr 27 2025 at 9:29am
For once I agree with you Jon! Yes, if the federal government were to somehow magically balance its budget tomorrow, that in itself would not end the trade deficit; the debt would just shift to the private sector in form of sub-prime mortgages, asset bubbles of various kinds, corporate debt, as you say, etc. Thus, until we get the trade deficit under control, it’s probably for the best if most of that debt burden falls on the government because they have more ways to deal with it.
Jon Murphy
Apr 27 2025 at 9:44am
Unless we’re assuming foreigners want to lose money for some reason, those first two are quite unlikely.
Craig
Apr 27 2025 at 10:16am
Some opine that the foreign money IS the bubble.
Warren Platts
Apr 27 2025 at 10:31am
That’s what Bernanke said was the root cause of the 2008 GFC…
Jon Murphy
Apr 27 2025 at 11:33am
If he said that, then it is wrong. The subprime mortgage crisis was an issue of regulation, not foreigners trying to lose money. Nobody willingly invests in things that will lose money.
Which is an extraordinarily goofy thing to claim.
Craig
Apr 27 2025 at 11:48am
Carry trades. Borrow in a currency at a low interest rate and throwing it at US stocks.
Warren Platts
Apr 27 2025 at 1:58pm
That doesn’t entail that they will not lose their money regardless! lol…
Roger McKinney
Apr 27 2025 at 10:55am
So who is buying all that debt? Of course, the Fed is by creating new money. But what happens when the Fed creates more new money than the nation wants to hold? They export the extra cash by purchasing imports. What do the foreigners do with their dollars? Their governments buy them then use them to buy US debt. That’s the longer way to say that foreigners buy US debt created by the federal government.
The trade deficit allows the US to export the inflation that the Fed’s money printing would create here. What would happen if the Fed didn’t print money to buy the debt created by the deficit? Interest rates on US debt would sky rocket.
Foreign holdings of dollars has decreased relatively, as a percentage of total. But not so much in absolute dollars.
Craig
Apr 27 2025 at 11:13am
The Fed is currently reducing its balance sheet. Of course they have increased it in the past. As of 2/25 foreign holdings of treasury holdings were still increasing, they increased by about $800bn y/y from 2/24. I do not have more recent data and obviously events in the interim events have unfolded which are obviously quite material.
Now the one thing I am unsure about on this chart:
https://ticdata.treasury.gov/resource-center/data-chart-center/tic/Documents/slt_table5.html
…is that the grand total is then sub-itemized into three categories. Those three categories do not add up to the grand total. So I’m not sure what counts here? This could be important with respect to multinational corporations and the retained earnings of their US subsidiaries, if a US subsidiary of a foreign multinational owns a bond does that ‘count’? I’m not sure.
Warren Platts
Apr 27 2025 at 9:25am
Respectfully disagree. The problem is not that Americans don’t save enough, it’s that certain foreign mercantilist countries insist on saving too much, causing a global savings glut. That excess savings has to go somewhere. And only the USA has superdeep, liquid, relatively safe capital markets. And so the excess savings wind up here. That’s really the root cause of the trade deficit.
Jon Murphy
Apr 27 2025 at 9:45am
This is probably the single strongest argument you’ve ever made against Mercaltilism and Trump-style tariffs. Bravo!
Warren Platts
Apr 27 2025 at 10:29am
Thank you Jon. I’m staunchly opposed to mercantilism. Always have been. As for Trump’s tariffs, my main complaint is that they don’t go nearly far enough. Tariffs on goods alone will not end the trade deficit because they don’t address the root cause. The root cause is not goods imports per se. Rather, it’s the capital inflows. Therefore, we also need tariffs on capital inflows (aka capital controls), say 100% on Chinese capital inflows, 20% on everybody else, and require foreign investors in U.S. stock markets to pay the same capital gains taxes that Americans have to pay (foreign investors in real estate are subject to the same capital gains taxes as American real estate investors, so there is plenty of precedent).
Jon Murphy
Apr 27 2025 at 11:34am
Ok. Then why do you spend the rest of your comment making a mercantilist argument?
Warren Platts
Apr 27 2025 at 2:01pm
Because it is not in fact a mercantilist argument. Perhaps, Jon, you could explain what you think mercantilism is. Then I could point out where you go wrong. Because clearly you are operating under some misperceptions.
Roger McKinney
Apr 27 2025 at 10:57am
It’s not possible to save too much. Besides, if foreigners didn’t save “too much,” who would buy US debt? Americans can’t.
Jon Murphy
Apr 27 2025 at 11:37am
I always hate the phrase “too much/too little.” It’s just naked central planning. The person making it presumes they know better than the people making their decisions.
Anecdotally, I suspect, though that the CCP agrees with Mr Platts that their citizens save too much. I mean, the Chinese government has been desperate to spend money, going deep into debt, and trying to stimulate spending by their own people as well.
Warren Platts
Apr 27 2025 at 2:05pm
It most certainly is possible. Google the Paradox of Thrift.