Explainer: What Trump aims to achieve with his new tariff plans

After promising during his election campaign to put import taxes back at the center of US economic policy during his second term as president, President Donald Trump took a dramatic step in that direction on 1 February.

Trump signed orders imposing across-the-board tariffs of 25% on imports from Canada and Mexico and 10% from China. The tariffs will take effect at 12:01 am on Tuesday, 4 February.

Source: Bloomberg

How radical is Trump's approach?

Some US tariffs on goods from those three counties already approach or even exceed the levels mandated by Trump. But these only apply to select categories of goods. Levying them across the board is a major departure.

Currently, for imported industrial goods, which make up 94% of US merchandise imports by value, the US has a trade-weighted average tariff rate of 2%, according to the Office of the US Trade Representative. Half of industrial goods enter the country duty-free.

What's Trump trying to achieve?

Scott Bessent, Trump's treasury secretary, provided clues about how his boss might employ new tariffs during his confirmation hearing in early January.

Bessent, a former hedge fund manager who helped his former boss George Soros bet against the currencies of other countries, told senators that people should expect Trump to use tariffs in three ways: to remedy unfair trade practices (which Trump has said would revitalize American industry), to raise revenue for the federal budget (important to help pay for Trump's plans to extend his 2017 tax cuts), and to use as a lever in negotiations with foreign powers in place of sanctions, which Trump believes have been overused.

Boosting American manufacturing: Trump has talked about using tariffs to revitalize manufacturing and stop the US getting "ripped off" by other countries due to trade imbalances. He's floated the idea of using a mix of tariffs and incentives such as expedited permitting approval as a way to entice companies to build their facilities in the US.

During his first presidency, he imposed several rounds of tariffs on Chinese goods, the impacts of which are still being assessed. Many economists believe they functioned as a tax on US consumers and held back US economic growth. Local manufacturers don't always leap in to start making products hit with levies. And if the nation imposing the tariffs has no alternative domestic supply of the goods concerned, then prices of those goods can go up.

None of this has dampened Trump's enthusiasm.

"We're going to bring the companies back," he said during an interview with Bloomberg Editor-in-Chief John Micklethwait at the Economic Club of Chicago in October. "We're going to lower taxes still further for companies that are going to make their product in the USA. We're going to protect those companies with strong tariffs."

Trump said he was just getting started using tariffs to remake the US economy during his first term when the Covid-19 pandemic hit and scrambled his plans. His nominee for commerce secretary, Howard Lutnick, framed the tariff plan as a means to regain the world's respect during his confirmation hearing, telling senators that US allies and adversaries alike "are taking advantage of us, they are disrespecting us and I would like to see that end."

Raising revenue: Income from tariffs could help pay for the tax cuts promised by Trump. He wants to extend reductions in income taxes that were approved in 2017 during his first presidency, many of which are due to expire at the end of 2025. He's even floated proposals for expanding these tax breaks, for example by exempting tips and social security earnings from taxation. He also aims to slash the corporate tax rate to 15% from 21%.

These measures are expected to lead to a loss in government revenue of $4.6 trillion over 10 years. Trump's tariff hikes, if implemented in full, could bring in as much as $2.5 to $3 trillion over that same period of time, according to Bessent.

Peter Navarro, a Trump trade adviser, told CNBC on Jan. 31 that the tariff effort can replace the revenue of tax cuts. "Tariffs can easily pay for that," Navarro said. "President Trump wants to move from the world of income taxes and countless IRS agents to the world where tariffs, like in the age of [President William] McKinley, will pay for a lot of government that we need to pay for and lower our taxes."

Wielding a weapon of diplomacy: Trump has become skeptical of sanctions because they drive other countries away from the dollar, and sees tariffs as a way to gain leverage in negotiations, according to Bessent.

Trump's brief January standoff with Colombia — in which he threatened to impose tariffs over repatriation flights for undocumented migrants — provided a glimpse of Trump's strategy. For a few hours, it seemed that a trade war between the US and one of its closest allies in Latin America was inevitable. Then Trump pulled back on his threat after an agreement was reached between the two countries. The White House claimed victory, saying Colombia had "agreed to all of President Trump's terms" and would accept deportees on US military aircraft. Colombia said deportees returned on its military plane.

Trump's tariff orders on Canada, Mexico and China are intended to address what he calls a "threat to the safety and security of Americans, including the public health crisis of deaths due to the use of fentanyl."

Is Trump's approach new?

The US taxed imports heavily for much of its history before largely abandoning the policy beginning in the 1930s, as government leaders embraced the idea of free trade.

A big reason for that was the reaction to the Smoot-Hawley Act of 1930, which led to an estimated increase of roughly 20% in average import duties. The act was intended to help mitigate the effects of the Great Depression but ended up making the situation worse. That debacle kicked off a multi decade period that saw the rise of free trade, which culminated in the creation of the World Trade Organization in 1995. During that time, tariffs became anathema to the Republican Party.

They made a comeback during Trump's 2017-2021 presidency, when he turned to them in an effort to revitalize American industry and counter what the US regards as China's unfair trade practices. President Joe Biden kept the trend going.

Source: Bloomberg

Can Trump raise tariffs without Congressional approval?

Yes. Through a number of statutes, Congress has empowered the US president to modify tariffs to address a variety of concerns. These include a threat to national security, a war or emergency, harms or potential harms to a US industry, and unfair trade practices by a foreign country. While companies might try to fight higher tariffs in court, because of past deference given to presidential powers, such challenges "would face a steep uphill climb," according to an article posted by the Center for Strategic & International Studies and co-authored by Warren Maruyama, a former general counsel for the Office of the US Trade Representative.

How do tariffs work?

A tariff, also known as a duty or levy, is usually calculated as a percentage of a good's value (as declared during the customs clearance process.) It can also be levied as a fixed amount on each item. Goods that cross borders are given numeric codes under a standardized nomenclature called the "international harmonized system." Tariffs can be assigned to specific product codes relating to, for example, a truck chassis, or to broad categories, such as electric vehicles. Customs agencies collect tariffs on behalf of governments.

Who pays tariffs?

Tariffs are paid by the importer, or an intermediary acting on the importer's behalf, though the costs are typically passed on. Trump argues that, ultimately, it's the exporter who effectively ends up shouldering the cost of a tariff. Studies have shown the burden is more diffuse. The foreign company that makes the product may decide to lower prices as a concession to the importer. Or it might spend significant sums to build a factory somewhere to sidestep the tariff. Or an importer — Walmart and Target are among the biggest in the US — could raise prices of the item when it's sold on. In this case, it's the consumer who shoulders the tariff cost indirectly.

How does China figure into all of this?

For decades, the belief in free trade was backed by a bipartisan consensus in the US and by multinational corporations that wanted access to cheap and efficient supply chains overseas. China's ascension as a global economic power broke the consensus. Admitted to the WTO in 2001, China gained greater access to global markets even as its critics say it violated the letter and spirit of free-trade rules, for example by subsidizing its industries and compelling foreign companies operating in China to part with their know-how. A number of researchers have concluded that competition from China triggered a decline in US employment among manufacturers that faced a surge in imports.

During Trump's first presidency, his administration imposed new tariffs on Chinese imports that were worth about $380 billion in 2018 and 2019. The Biden administration maintained those levies and raised more of them in 2024 on goods worth an additional $18 billion. The new enthusiasm for tariffs has spread to the European Union. It voted in early October to impose duties as high as 45% on electric vehicles from China, which in turn has threatened to retaliate against European products.

On the 2024 campaign trail, Trump argued that across-the-board import taxes would have benefits beyond defending domestic industries: They would flood the Treasury with billions of dollars in revenue, push companies that don't produce goods in the US to do so, and enable the US to extract concessions from trade allies and rivals alike.

How have tariff hikes affected the US so far?

It can be difficult to sort through the economic effects of tariffs. They can stimulate employment by attracting investment as companies try to get around tariffs by moving factories to the taxing country. At the same time, they can provoke retaliatory tariffs that cost jobs in other parts of the economy.

One potential problem with tariffs is that local manufacturers won't always leap in to satisfy domestic demand for a good subject to new tariffs. And if the nation imposing the tariffs has no alternative domestic supply of the goods concerned, then prices of those goods can go up.

Economists are still untangling the inflationary effects of Trump's initial tariffs from a much bigger shock to supply chains and economic activity that started not long after the US-China trade war began: the Covid-19 pandemic.

In February 2019, the Federal Reserve Bank of San Francisco estimated that the tariffs were adding 0.1 percentage point to consumer price inflation and 0.4 percentage point to a metric that measures the costs for businesses to invest. Erica York, senior economist at the nonpartisan Tax Foundation, estimated that the higher tariffs imposed by Trump and Biden increased annual costs for US households by $625.

In addition, York estimated that the hikes would eliminate 142,000 full-time jobs and, over the long run, would reduce long-run gross domestic product by 0.2% on average. Critics of Trump's further drastic tariff increases say it would have the same kinds of effects at a greater scale.