Tariffs: Friend or Foe?

Weekly Blog #5 

“Trade protection accumulates riches for a few while the many grow poorer.” Adam Smith 

A tariff is, at its core, a tax on imported goods. While taxes on income and property are familiar to most people, tariffs tend to operate more quietly in the background, much like Europe’s ubiquitous VAT tax, hidden in the price of goods and the cost of doing business. But despite their quiet nature, tariffs have played a significant and often contentious role in shaping economic policy and global trade for centuries.

In the early days of nation-building, tariffs were a practical necessity. Developing and non-advanced nations—particularly those with limited domestic production capacity—relied heavily on tariffs as a primary source of government revenue. In the absence of a sophisticated tax system, imposing duties on imported goods was a straightforward way to generate the funds needed to build infrastructure, support national defense, and establish a functioning state. For the United States, tariffs were the government’s main source of revenue for well over a century. Between 1790 and 1914, tariffs accounted for roughly 80% of federal income. Alexander Hamilton, the nation’s first Secretary of the Treasury, argued that tariffs were not only a means of raising revenue but also a way to protect fledgling American industries from more established European competitors.

Things began to shift in the early 20th century. The introduction of the federal income tax in 1913 under the 16th Amendment provided a more stable and efficient way for the government to collect revenue. Unlike tariffs, which indirectly tax consumers through higher prices on imported goods, income taxes could be adjusted to reflect economic conditions and the government’s financial needs. As the federal income tax system matured, tariffs gradually took on a different role. Rather than serving as a primary revenue stream, tariffs became a tool of economic strategy—a lever to protect domestic industries, influence trade balances, and, at times, punish bad behavior by trading partners.

At their best, tariffs can be a useful bargaining chip. When one country imposes unfair trade practices—currency manipulation, protectionist subsidies, dumping products at below-market prices, or engaging in restrictive trade barriers—tariffs can serve as a form of economic retaliation. Ronald Reagan famously used this approach in the 1980s when Japan was flooding the U.S. market with underpriced semiconductors. The Reagan administration imposed 100% tariffs on certain Japanese products, which ultimately forced Japan to negotiate more balanced trade terms. In this sense, tariffs can be viewed as a cudgel—a blunt instrument to compel trading partners to play fair.

But tariffs are not without their downsides. At their core, tariffs are a tax on consumers. When the government imposes a tariff on imported goods, the cost doesn’t disappear—it gets passed on to businesses and, ultimately, to consumers in the form of higher prices. If a 25% tariff is placed on Chinese steel, for example, domestic manufacturers using that steel will face higher input costs, which leads to higher prices for finished products. In the short term, tariffs can create scarcity, increase prices, and reduce purchasing power. In the long term, they discourage innovation and capital investment by creating artificial barriers to competition.

Tariffs also have a tendency to trigger retaliation. If the U.S. imposes tariffs on European automobiles, the EU may respond with tariffs on American agricultural products, escalating into a full-blown trade war. The Smoot-Hawley Tariff Act of 1930 is the classic cautionary tale. In an effort to protect American farmers and manufacturers during the Great Depression, Congress passed one of the most restrictive tariff bills in U.S. history. The result? Trading partners responded with tariffs of their own, global trade contracted, and the Depression deepened. Protectionism backfired, and the cure was worse than the disease.

Free and fair trade is one of the greatest engines of prosperity the world has ever known. Ricardo’s theory of comparative advantage—where nations specialize in producing what they do best and trade for the rest—has created wealth on an unprecedented scale. It’s no accident that the explosion of global trade in the latter half of the 20th century coincided with an extraordinary rise in global living standards. When markets are open, competition drives down costs, encourages innovation, and increases choice. Free trade promotes efficiency by directing resources toward their most productive use, maximizing output, and enhancing overall wealth.

Tariffs, by contrast, distort market forces; they interfere with price signals, create artificial scarcity, and limit consumer choice. Subsidies—the inverse of tariffs—are no better. When governments prop up domestic industries with direct payments or tax incentives, they encourage inefficiency and misallocation of capital. When the state picks winners and losers, the people suffer. Ultimately, economic freedom—not protectionism—creates prosperity.

That said, free trade only works when all parties play by the same rules. And that’s where tariffs can be strategically useful. If one country manipulates its currency to make its exports cheaper or subsidizes key industries to undercut foreign competitors, imposing tariffs can serve as a corrective measure—a way to level the playing field. The goal isn’t to build a permanent wall around domestic industries but to use tariffs as a negotiating tool to secure freer, fairer trade terms. Ideally, tariffs should be temporary, targeted, and tied to specific policy objectives. The endgame isn’t autarky—a self-sufficient economy cut off from the world—but a trading system where market forces, not political distortions, determine outcomes.

Autarky, after all, is a fool’s game. North Korea is a textbook example of the poverty that results from isolation. Compare that to South Korea, which embraced global trade and became an economic powerhouse. The lesson is clear: open markets create prosperity; closed markets create stagnation and poverty.

At the end of the day, tariffs should be viewed not as an economic strategy but as a means to an end—a tool to compel other nations to engage in open, fair, and reciprocal trade. The ultimate goal isn’t more tariffs; it’s no tariffs. A world where goods, services, and capital move freely across borders creates more output, lower costs, greater innovation, and more abundance. And that’s a win for everyone.

Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™