Cleveland Fed, Report: On the Distributional Effects of International Tariffs

“The rise in anti-trade policies and retaliatory actions in recent years has motivated us to ask the question: What are the distributional consequences of global tariffs?” To this end, we have studied the distributional effects of the 2018 tariff increases in an overlapping generations Ricardian trade model with uninsurable income risk, incomplete asset markets, capital-skill complementarity, and non-homothetic preferences. Tariffs reduce allocative efficiency and increase the prices of tradable goods and investment, but the revenue generated from tariffs can be used to reduce other distortionary taxes. We find that the increase in tariffs by the US and its trading partners reduced US average welfare by 0.1 percent, with larger losses concentrated among retirees and low-wealth workers.”

“When we isolate the pure consequences of the tariffs, we find that they lead to substantial declines in aggregate capital and consumption; however, when we use tariff revenue to reduce taxes these negative effects are largely offset. Using tariff revenue to reduce capital income taxes leads to higher levels of economic activity, but also to larger and more unequally distributed welfare costs than does reducing labor income taxes. Consumption tax reductions or lump-sum transfers can produce an average welfare gain, even with retaliatory tariffs. While our baseline model abstracts from labor market frictions or geographical heterogeneity, we leave these potentially fruitful extensions for future research.”