Trump’s tariff agenda has not only dominated the headlines but also rattled global markets. As I write this piece, we are enduring one of the most volatile stretches in the history of U.S. and global equities. My goal herein isn’t to litigate whether the administration’s policy is right or wrong, but rather to provide clarity on why and how these steps may work to balance the American budget if we take administration officials at their word. One of the reasons for the violent swings in the market is because the messaging from Washington has been unclear, and our client families look to us to provide clarity especially when there is none.
According to administration officials, tariffs are being introduced because global manufacturing has long-favored foreign producers. American consumers have generally welcomed this development because they have benefitted from low prices thanks to the absence of tariffs on goods and materials imported from other countries. The cost of cheap goods, however, has been shouldered by the middle-and-working class Americans whose wages have stagnated for decades as manufacturing jobs have been shifted overseas. Many of America’s allies and trading partners have been allowed to impose tariffs on American goods coming to their countries, while the US for the most part, has enabled goods to freely come into our country. Cheap goods have been an obvious benefit for American consumers over the last several decades and it would be nice to continue that luxury, but over that period of time the Federal Government has amassed a massive spending deficit and debt that is spiraling out of control.
According to JP Morgan Chase, the US currently has an annual federal deficit of nearly $2 trillion, and a ballooning national debt of over $36 trillion. The chart above describes the Federal Budget. On the left side of the chart, you can see that the government’s Total Spending is approximately $7 trillion annually, while the Sources of Financing only amount to $5.2 trillion: the government spends roughly $2 trillion more than it earns each year. It would be like having an income of $50,000 per year, spending $70,000 per year, and piling on a $360,000 mortgage.
The US Government’s income comes from two sources: tariffs and taxes. In the chart above you can see that the US receives approximately $80 billion per year from tariffs, while the majority of our revenue comes from corporate, payroll and individual income taxes paid by Americans and their employers. Only 1% of revenue is generated by tariffs, but according to most economists, the United States accounts for approximately 30% of all global goods consumption, despite producing only 15% of the world’s manufactured goods. (source Census.gov) The US buys about 1/3rd of all goods produced throughout the world; the Trump administration is attempting to leverage that fact to drive more revenue.
The administration’s strategy is to leverage the strength of the US consumer to drive more revenue through tariffs and renegotiate trade deals to establish a fairer playing field so that American manufacturers have a higher likelihood of selling their products overseas. Among the many reasons why the markets have reacted negatively is because this policy represents a complete restructuring of the global supply chain and companies are going to have to adjust their business models which will cost time and money. Uncertainty is high because the messaging from Washington hasn’t been clear or has been drowned out in a sea of social media, but it’s important we allow these negotiations to play out. Some countries may agree to fairer terms, leading to freer trade which is a potential win because US goods will be more competitively priced overseas. Others may refuse to negotiate, and face tariffs on their own goods which could drive more revenue to the US budget and potentially improve US manufacturing.
Yes, prices on goods and services will likely rise, but the pain of higher prices may be offset by the Trump Administration’s next agenda item: tax reform. There are proposals in motion to eliminate or significantly reduce federal income taxes for middle and lower-income Americans. The best way I can analogize what’s happening here is to think about the US states that charge no state income tax like TN, FL, and NV. Ask yourself the following question: would you rather pay taxes on your income, which is something you can’t control, or on your expenses, which is something you can control?
Of course, some expenses are non-discretionary like groceries and utilities so you can’t have complete control over your spending, but the idea remains: shifting taxation from income to consumption could potentially give Americans more financial autonomy, while driving more revenue to the Federal Government. If income taxes for those earning under $150,000 (including those who rely on tips and social security) drop to zero, the vast majority of Americans would no longer pay any Federal Income tax which could offset the rising cost of goods from tariffs.
The federal government must somehow be funded, whether through tariffs or taxes, revenue is essential. If the US implements a zero-income tax policy along with tariffs, the Administration’s hope is that the federal budget will look more like the states with no state income tax. In TN, for instance, there is a 9.5% sales tax, so groceries, cars, clothing, etc. are more expensive in TN than in KY. But if you ask TN residents if they’d want to pay the 4.5% state income tax levied in KY but lower their sales tax, you’d be hard-pressed to find one who would. The reason is because TN residents have control over their spending and therefore have more control over the taxes they pay. The State of TN remains well-funded, and more people are moving in than moving out. The model works on a state level, and it seems that the Trump Administration is trying to implement a similar model on a national level.
Ultimately, success depends on whether the Trump administration can use tariffs as a negotiation tool to achieve global fair trade, drive more revenue to the federal budget, and whether Congress can deliver on meaningful tax reform. If both happen, we do see a path where U.S. may generate sufficient revenue to balance the budget, lower debt, produce more manufacturing jobs in the US, and encourage free and fair trade across the world. The main risk is that trade wars escalate and cripple the global economy. Only time will tell.