Fewer than half of Americans even claim to understand how tariffs work. Do you?

If not, please don’t feel bad.

I sat through at least one class in graduate school (at Stanford) on the subject of tariffs. That’s more, I suspect, than most people. And yet, when President Trump put them back in the headlines, I still had to sit down and renew my understanding.

Are tariffs good, bad, neither—or does it depend?

I was trained as an economist in the 1980s. In those days, as today, most economists were firm in their belief that tariffs are bad because tariffs reduce the amount of trade, and raise the costs of goods.

This is true, as far as it goes. But it is a strangely myopic view of the world.

Most economists, even liberal economists like Paul Krugman, decry tariffs. Krugman, during the 2024 presidential campaign, said:

“Tariffs… would cause us to sell less of the goods we currently export—that is, stuff we’re relatively good at producing—and more stuff we aren’t that good at producing. The effect would be to make the economy less efficient and poorer.”

Krugman is right. But he, and most economists of his ilk, miss the forest for the trees.

The reason tariffs cause those negative consequences is that tariffs are taxes.

Essentially all taxes “make the economy less efficient and poorer.” And the higher the taxes, the greater the impoverishing effect.

If You Tax Something, You Get Less of It

One of the lessons that students learn in economics 101 is that, everything else equal, when the price to buy an item rises, less of that item will be bought. In the language of economics, less will be demanded.

A sales tax raises the total price to the buyer, and therefore reduces demand. This means that the buyers buy less than they would otherwise, and the sellers sell less than they would otherwise.[1]

An example that most people are familiar with is the very high taxes on cigarettes. In the US, the average price of a pack of cigarettes is about $8. Of that, about $3 is sales taxes (federal plus state). That’s a rate of about 60%! (I.e. $3 tax on top of $5, for a total of $8).

The main justification offered by proponents of cigarette taxes is that taxes reduce consumption. For example, the American Lung Association “strongly supports efforts on the national, state and local levels to increase taxes on cigarettes and tobacco products.”[2] They argue: “Every 10 percent increase in the price of cigarettes reduces consumption by about four percent among adults and about seven percent among youth.”

If You Don’t Complain About Sales Taxes, Don’t Complain About Tariffs

A tariff is a sales tax, but one that only applies to imported items. If the tariffed item is available only from import, the tariff functions exactly like a sales tax. Thus, if you’re okay with sales taxes, you have no economic leg to stand on in opposing tariffs.[3]

Income Taxes Are Devastating—To the Country

If you tax something, you get less of it.

The worst tax, in terms of impoverishing ALL Americans (indeed, the whole world), is the income tax.

Most people want more income. Yet by far the biggest tax in the US is the federal income tax.

Remember, if you tax something, you get less of it.

And in fact, the income tax has had a devastating effect on income, and its close cousin, Gross Domestic Product (GDP), since the adoption of the income tax in 1916.

Harvard’s Martin Feldstein, in a set of papers[4] estimated that the US federal income tax has reduced economic growth by between 1% and 2% per year. The cumulative effect of that retarded growth is tens of trillions of dollars in lost GDP.

Have you ever heard Krugman, and his ilk, even mention the devastating effect of income taxes? Probably not. Instead, such polemicists (some of whom were trained as economists) are more likely to be claiming (without economic justification) that income taxes should be higher.

Capital Gains Taxes—And How to Avoid Them

When you tax something, you get less of it. So capital gains taxes, which are taxes on the successful investment of capital, mean that you get less capital investment. That’s one important reason that many countries, including first world countries like New Zealand, Switzerland, and Singapore, don’t tax most capital gains.

But the US does tax capital gains, unless you know legal ways to avoid capital gains taxes. To learn more about these legal methods, click here to request a free copy of your advisor guide.

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_{[1] Not only does society produce and consume less of what is taxed, but taxes also destroy value in another way called “deadweight loss.” As we’ll see later, in the case of the income tax, that deadweight loss is of truly breathtaking magnitude, and yet almost no one talks about it.}

_{[2] https://www.lung.org/policy-advocacy/tobacco/tobacco-taxes}

_{[3] Tariffs, e.g. as Trump is using them, can also be a political tool. Tariffs as a tool of foreign policy are a different discussion. In such a discussion, the economic costs of a tariff should be weighed against the benefits of the policy, and the costs of alternative policies, and of course against the cost or benefit of doing nothing.}

_{[4] E.g. The Welfare Cost of Capital Income Taxation, Journal of Political Economy, Vol. 86, No. 2, 1978, and Tax Avoidance and the Deadweight Loss of the Income Tax, Review of Economics and Statistics, Vol. 81, No. 4, 1999.}