NTA Spring 2025: Tariffs
MODELING THE BUDGETARY, ECONOMIC, AND DISTRIBUTIONAL IMPLICATIONS OF TARIFFS (Paper Session)
Moderator:
Molly Saunders-Scott, Congressional Budget Office
Who Bears the Burden? A Description of How the Tax Policy Center Estimates the Distribution of Tariffs.
Rob McClelland, Tax Policy Center
Understanding the Implications of Tariffs
Erica York, Tax Foundation
Kyle Pomerleau, American Enterprise Institute (Co-author)
The Fiscal & Macroeconomic Effects of ‘Reciprocal’ Tariffs
Ernie Tedeschi, Yale University
RobMcClelland's analysis reveals that the burden of tariffs is often passed on to consumers in the form of higher prices, disproportionately affecting lower-income households. This shift in cost can lead to increased economic inequality, as these households spend a larger percentage of their income on essential goods.
Distributing Tariffs: Connecting Revenue and Burden
When distributing tariffs, it's crucial to connect revenue and burden.
The process starts with a revenue estimate, recently extended to eleven-year estimates.
The year 2026 is used as the baseline for establishing tariff amounts and burdens.
The change in burden is determined by comparing baseline tariff amounts with proposed alternatives.
Calculating Tariff Burden
Tariff burden is assessed by multiplying the tariff rate by the imports under the baseline.
For alternatives, new tariff rates are used with original baseline imports.
This approach avoids underestimating the burden when tariff rates increase but revenues fall due to collapsed imports.
Using baseline imports helps measure deadweight loss, especially when elasticities are low and tariff rate changes are minimal.
Addressing High Elasticities and Trans-shipping
Current scenarios involve significant tariff rate changes, especially for China, with highly elastic imports.
The Tax Policy Center (TPC) uses 85 separate elasticities, with a median of -1.5, ranging from -4.5 to -0.5.
The model accounts for potential trans-shipping across countries, as evidenced by past events (e.g., Vietnam in 2018).
The baseline imports assume no change in consumer behavior, focusing on sellers' adjustments.
Estimating Deadweight Loss
Revisions to burden calculations are being considered for a better estimate of deadweight loss.
The current approach is adequate when elasticities are low but may not be optimal for higher elasticities.
Intermediate Goods and Forward Linkages
Almost half of imported goods are intermediate goods.
The TPC uses Input-Output (IO) tables to trace these goods through the economy to final consumption.
A new output matrix has been constructed for final demand, including personal consumption expenditures.
Example: Restaurants, a service, rely on intermediate goods like food, affecting restaurant prices.
Forward Linkages Approach
The forward linkages approach assumes the tariff burden is entirely passed on to consumers.
Changes in profits or employment levels are not considered.
Once burdens are determined by NAICS classes, they are treated like excise taxes.
Advantage: TPC already knows how to distribute excise taxes.
Distributing Taxes: Income vs. Consumption
Tariffs are often considered regressive when measured by consumption.
They are less regressive, but still regressive, when measured by income.
TPC distributes by income due to several reasons:
Tariffs reduce the purchasing power of real income.
Easy to include in direct tax offsets (e.g., personal income, corporate income, payroll taxes).
Allows for mixing and matching policy changes (e.g., tariffs and standard deduction changes).
Alternative Method: Consumption-Based Distribution
Distributing based on imputed measures of consumption typically shows tariffs as highly regressive.
This is because consumption is more equally distributed than income.
Consumption smoothing can make lower-income individuals appear to spend a higher proportion of their income.
Life cycle effects also skew consumption patterns.
Limitations of Consumption Data
The Consumer Expenditure Survey (a one-year cross-section) is the primary source of consumption data.
It may not accurately measure income at the bottom or top of the income distribution.
Ideally, panel data would be used to follow individuals over time and account for consumption and income smoothing.
Impact on Income Quintiles
Lowest income quintile loses 2.6% of pre-tax income due to tariffs (as of April 9).
The top income quintile loses 1.7%.
Overall, this distribution is regressive but less so than consumption-based measures.
Erika expected this trend to impact consumer spending and economic growth, particularly among lower-income households.
Macro Effects of Tariffs on Economic Output
Tariffs affect economic output by influencing the supply of labor and capital.
Labor supply responds to after-tax wage rates, while capital supply responds to the cost of capital.
Tariffs on final consumer goods act as a consumption tax, reducing income available for workers and capital owners.
This can lead to lower real after-tax wages, reducing work incentives and lowering total output.
Tariffs on Intermediate and Capital Goods
About half of U.S. imports are intermediate inputs or capital goods (more than 50% if including auto trade).
Tariffs on these goods act more like a tax on capital investment.
They increase the relative price of capital goods, directly reducing capital investment, productivity, and wages.
This ultimately functions similarly to an income tax.
Additional Negative Economic Impacts
Tariffs misallocate resources across the economy by changing relative prices.
Resources shift from higher-taxed areas to lower-taxed areas, reducing overall output.
They can reduce productivity growth by limiting foreign competition and reallocating activity to less efficient producers.
Tariffs create a protected domestic market, reducing the incentive for firms to seek efficiencies.
Retaliation and Revenue Effects
U.S. tariffs invite foreign retaliation, further negatively impacting the U.S. economy.
Conventional revenue estimates, used in official scorekeeping, hold nominal national income constant.
Dynamic estimates incorporate policy changes' influence on output and related revenue implications.
Revenue Estimates and Elasticities
Both conventional and dynamic estimates start with direct tariff revenue (tax rate * tax base).
The tax base changes due to substitution and trade diversion.
An elasticity of -0.76 is used in the first year, growing to -2 by 2032.
A 15% noncompliance rate is applied, consistent with the average across tax types and VAT estimations.
Income and Payroll Tax Offsets
Tariffs reduce the real tax base of income and payroll taxes, requiring offsets.
This is not a dynamic effect but a mechanical one due to the reduced income for firms and workers.
The Treasury Department assumes a 25% offset; JCT uses an average of 26.2%.
Dynamic Revenue Estimates
Gross tariff revenue for a 10% universal tariff is estimated at over ten years.
After offsets, it falls to about .
Using Tax Foundation's model, a 10% universal tariff reduces long-run GDP by 0.4%.
This model treats tariffs like an excise tax, capturing the tax wedge on labor but not other negative impacts.
The GDP reduction offsets about in revenue, resulting in a dynamic estimate of over ten years.
Ernie from the Yale Budget Lab notes that while tariffs may initially seem beneficial for domestic production, the long-term consequences often outweigh short-term gains.
Macroeconomics of Tariffs: Budget Lab Approach
The Budget Lab uses the GTAP model (General Trade Analysis Project) for medium to long-run analysis.
GTAP is a comparative statics general equilibrium model.
For short-run effects, they use the MAUS model, a large structural macroeconomic model.
They also use input-output matrices, employment requirement matrices, and the consumer expenditure survey.
Price Effects and Modeling Assumptions
Tariffs create a wedge between prices paid for imports and net income received by retailers.
The Budget Lab assumes a 100% pass-through to consumer prices, even for intermediate goods.
Dollar appreciation is assumed to offset about one-third of the tariff cost under no retaliation.
Retaliation gradually neutralizes this dollar effect.
Domestic pricing increases competitively due to rising competitor costs.
The Federal Reserve is assumed to look through price pressure without policy response.
Modeling Prices: Pre- and Post-Substitution
Prices are modeled pre- and post-substitution.
Pre-substitution assumes no substitution among businesses and consumers, showing the full welfare effect.
Post-substitution adjusts import shares and consumption based on consumer and business choices.
Under 2025 tariffs, the pre-substitution PCE price impact is 3%, while post-substitution is 1.5%.
Consumer and business choices mitigate about half the effect.
Distributional Analysis: Sources vs. Uses Approach
The sources and uses approach should align over the long run if all income is eventually spent.
The sources approach uses income data, which is more reliable at granular household levels.
Life cycle distribution is a valid metric.
The uses approach, based on consumption data, aligns with other economic metrics on a cross-sectional dynamic basis.
Short-Run and Long-Run Effects in Models
In the short run, the MAUS model treats tariffs as a special indirect excise tax.
This wedges the price of business value-added and reduces import demand, partially offset by an increase in the dollar's value.
Long-run labor supply channels are being considered more.
In the long run, tariffs reduce potential GDP primarily through lower productivity (TFP and capital stock).
Sectoral and Revenue Effects
GTAP shows the long-run GDP is down by 0.6%, but there's reallocation among sectors.
Tariffs increase output and employment in manufacturing but are offset by declines in other sectors.
Output effects come from GTAP, translated into employment effects using BLS's employment requirements matrix.
Revenue effects are scaled using changes in effective tariff rates from GTAP and CBO's baseline.
CDO rules of thumb reduce the dynamic score by about lower when you incorporate, $2.4 trillion scored conventionally over ten years.
Group Q&A
Concerns and Uncertainties in Estimating Tariff Effects
Elasticities used in revenue projections are based on models with small tariff changes.
Applying these to large tariff rates (e.g., 45%) raises concerns about out-of-sample predictions.
Noncompliance levels and their inclusion in trade elasticity measures are also uncertain.
The impact of uncertainty effects is hard because consumer and business behaviors in the model assume exactly what the new tariff rate will be.
Risk vs. Uncertainty
AI: The uncertainty worries a lot. Risk is existential, where firms don't know the distribution of tariff outcomes next year, but they have to make decisions now.
Short-Run vs. Long-Run Effects
Consumers make choices, so the estimate of a % increase to consumers may not be what the final price point is.
Need to face that reality when calculating tariff effects.
Additional Economic Effects to Consider in Tariff Modeling
Look at alternative ways besides relying on what the data suggests from elasticities.
Considered some of the effects can include cyclicality. The reality is what the economy is facing.
Cyclical and short-run effects lead to asymmetric situations from the Fed, which can be hard to gauge.
Look at the impact of magnitudes as well. Should model a per capital tax impact with no social effects versus a gross margin tax.
Retaliation of trade due to tariffs can cause an even worse effect.