The Costs of Tariffs in the U.S.-China Trade War

The Issue:

The tariff war imposes costs on U.S. consumers, firms, and farms. As trade tensions between the United States and China escalate with increasing tariff rates and a broadening set of goods subject to fees, costs of the spat are likely to rise. But determining who bears the bulk of these costs can be complicated. Economists have begun to analyze the initial impact of the first sets of tariffs — giving a first glimpse of how these taxes on imports are being absorbed across the U.S. economy. These studies also provide a way of thinking about how the costs of further escalation might be distributed. Based on these recent economic studies, one can estimate that a tariff on all U.S. imports from China could cost the typical U.S. household between $300 and $800 a year. The retaliatory tariffs also hold risk for the U.S. economy. Although China buys much less in exports from the United States, U.S. exports to China support nearly 1 million American jobs and U.S. agricultural exports have fallen by half since 2017.

Consumers and the firms that make and buy goods subject to tariffs can all pay a portion of the cost. Determining how much is an empirical question.

The Facts:

• U.S. consumers and the firms that make, trade, use, and sell the goods subject to tariffs can all pay a portion of the cost of the tariffs. Determining who pays how much is an empirical question. Tariffs are a tax charged on goods as they enter a country. In practice, the fee is paid by the importer of record — the company that brings the goods into the country. But, determining who ultimately bears the cost of the fee is a different question. Thus, a key question is “How much does the cost of the tariff pass through to the prices paid in the United States?” Chinese producers could potentially absorb some of the cost by lowering their prices and reducing their profits. The costs could also be potentially absorbed by U.S. firms who buy the Chinese products either to sell to consumers or to use as inputs for producing other goods. Or, U.S. consumers could bear the cost of the tariffs in the form of higher prices on the finished goods. Exactly what fraction is borne by whom can depend on how sensitive consumer demand is to price increases, whether there are replacements for the good produced by domestic or other foreign suppliers, whether the goods are used as parts in integrated supply chains, and other factors.
• Tariffs on goods traded between the U.S. and China have increased in several stages since early 2018. Under Section 301 of the Trade Act of 1974, which allows retaliation against trading partners for unfair trade practices or non-market behavior, the Trump Administration has imposed tariffs on U.S. imports of Chinese goods in four stages. The first two stages began in July of 2018 and imposed 25 percent tariffs on a total of $50 Billion of U.S. imports from China. The third stage, in September 2018, imposed a 10 percent tariff on an additional $200 Billion worth of imports from China. In response to these initial stages, China retaliated by imposing 25 percent tariffs on $50 Billion of U.S. exports to China and later tariffs between 5 and 10 percent on about $60 Billion of U.S. exports to China. Most recently, a fourth stage has begun. On May 10, 2019, the Administration increased the 10 percent tariffs from stage 3 to 25 percent and the United States Trade Representative on the same day released a statement reporting its intent to impose a 25 percent tariff on all remaining U.S. imports from China, about $300 Billion. On May 13, 2019, China responded announcing it would raise tariffs, reaching up to 25 percent for most of the goods on its $60 billion list starting June 1, 2019 (see here for a trade war timeline).
• Recent research shows that the new tariffs are completely passed through into increased prices paid by U.S. importers as the targeted goods cross the border and result in higher costs for U.S. firms. Most of the Chinese goods targeted by tariffs so far have been goods purchased by firms as inputs into their own production (see here). Firms may absorb some of the increase in prices of imported inputs by adjusting markups or try to minimize the cost increase by making substitutions. New research by Fajgelbaum, Goldberg, Kennedy, and Khandelwal finds evidence strongly suggestive that the importer of record bears the full burden of the tariff, that exporters generally are not absorbing part of the tariff burden by lowering their prices. The authors relate the increase in tariff-inclusive prices for goods used by firms to increases in the Producer Price Index (PPI), suggesting that the costs of the tariffs on imported inputs are passed on to and by the firms who use them. They also find that the spike in tariff-inclusive prices is associated with a more than 30 percent drop in imports of targeted products. A separate study conducted by Amiti, Redding, and Weinstein uses a different method of analysis that also finds full pass-through of tariffs into the import prices of targeted products as they cross the border. Then, they carefully trace how the tariff-induced increases in imported input prices filter through the supply chain. They demonstrate substantial pass-through of increased input prices both by producers using imported goods targeted by tariffs and by producers protected by the tariff who can now raise prices due to the new tax on rival foreign goods. In the end, Amiti, Redding, and Weinstein find these tariff-inclusive and tariff-protected price increases appear to raise the Producer Price Index (PPI) by one percentage point. This is considerable in that it is half as much as the PPI rises in a typical year. Both of these studies indicate that the tariffs are increasing costs of production and reducing purchases of targeted goods; therefore, the results strongly suggest that the tariffs are disrupting supply chains for U.S. firms. Since these new tariffs and resulting input price increases are not faced by competing producers in other countries, they may put U.S. firms producing tradable goods at a significant cost disadvantage. Adding to these disruptions, the amount of cash that importers must put down as a guarantee for the increased tariff payments on targeted items, called customs bonds, also has increased dramatically, a problem that may hit smaller operations particularly hard.
• Have increased production costs for U.S. firms that depend on Chinese inputs translated into higher consumer prices? Even though it is difficult to trace changes in individual imported products into categories of consumer prices measured at the retail level, Amiti, Redding, and Weinstein are able to do so for appliances, where they show a strong association between increases in tariff-inclusive prices at the border and the index of consumer prices collected at points of final purchase. (Washing machines offer another concrete example. Although imposed under a different set of circumstances than tariffs on Chinese goods, the 2018 safeguard tariffs on washing machines were fully passed through to consumers at the retail-brand level, according to one study. In addition, the study authors find that domestic producers raised their prices in response to the higher prices of foreign rival suppliers and prices on dryers, often sold as a pair with the washers, increased by the same amount.) Moreover, prior research has found that competition with imports from China has induced competing producers to reduce markups in the U.S. market, suggesting that protection from this competition is likely to reverse that trend.
• Given the evidence that tariff rates are being passed on to a large extent to U.S. firms and consumers, how would we expect the different tariff waves to add up for the average U.S. household? The additional costs that households may bear as a result of increasing tariffs will vary greatly from one household to another and depend on their particular purchases. It is difficult to estimate the average costs across households with precision, but different studies give a range of possible values. Assuming full pass-through of tariffs into prices (but none of the increases in markups which we observe in the data for protected goods both within the supply chain and at the retail level) the New York Times published estimates of these costs by income group based on work by Borusyak and Jaravel. For the average household, they find that the cost of the tariffs on solar panels and washing machines, steel and aluminum, plus the first two stages of tariffs on U.S. imports from China would ultimately cost the average household about $60 per year. Adding the third stage of tariffs on U.S. imports from China (10 percent on an additional $200 Billion in imports) increases that cost to $127. Adding a 10 percent tariff to all remaining U.S. imports from China, approximately $300 Billion in additional imports, raises the cost to $270 per household. This method can be extrapolated for a rough estimate of the total cost of tariffs given the increase of the third stage of China tariffs from 10 to 25 percent, which actually happened on May 10th, and expanding these 25 percent tariffs to all other goods that the United States imports from China, formally announced by the United States Trade Representative to be in process. Doing so, I find that adding the total cost of all of the existing and planned tariffs on Chinese goods as of May 10th to the average household may reach roughly $500 per year. Other estimates arrive at a higher average cost. The Trade Partnership in February 2019 released a study estimating that a subset of these tariffs — the cost of steel and aluminum tariffs plus a 25 percent tariff on the goods in the first three stages of China tariffs ($250 Billion total) — would cost the average household $767 per year, or more if the tariffs are expanded to the rest of U.S. imports from China. As a lower bound estimate, both Borusyak and Jaravel using the Consumer Expenditure Survey and a study from the Federal Reserve Bank of San Francisco using measures from Personal Consumption Expenditures, find that imports from China account for between 1.5 percent and 2.5 percent of U.S. household consumption. Applying the midpoint of these estimates, 2 percent, to annual expenditure for the average U.S. household in 2017 ($60,000), suggests that raising the cost of all goods imported from China as they appear in final consumption could increase the cost of the current consumption bundle for the average household by $300. To put these estimates in perspective, the range of $300 to $800 per year is comparable to between 1/3 and 9/10 of the amount of the tax cut received by a household in this income range under the 2017 tax reform.
• What is the impact of the tariffs on U.S. jobs? Because production can increase in domestic firms whose products are protected from foreign competition by tariffs, estimating the jobs impact of tariffs has to take into account jobs gained, as well as those that are lost due to retaliation. The study of the tariffs on washing machines estimates that about 1,800 U.S. jobs have been created as a result of the safeguards on washing machines, with an average cost to consumers of $815,000 per job created, net of tariffs collected. A recent study by Hufbauer and Jung finds that increased costs for steel users due to U.S. steel tariffs amount to $650,000 per steel job created, with total costs of the steel tariffs as high as $900,000 per job created. The Trade Partnership estimates that steel and aluminum tariffs plus a 25 percent tariff on the goods in the first three stages of China tariffs ($250 Billion total) may create 126,900 jobs over 3 years, but cause 1,061,400 workers to lose jobs due to retaliatory tariffs and other costs, with a net cost of $490,900 for each job created. The U.S. Department of Commerce International Trade Administration estimates that just under 1 million U.S. jobs were supported by U.S. exports to China in 2015. Many of these could be put at risk due to retaliatory tariffs. In fact, Fajgelbaum, Goldberg, Kennedy, and Khandelwal show that retaliatory tariffs have eroded real wages in the most exposed local labor markets.