Editor’s Note: This article provides an accurate overview of key tax changes and policy actions initiated by the new administration. However, the pace of legislative and executive developments in Washington remains extraordinarily rapid. More recent actions—particularly shifts in tariff policies—may have a larger impact on the economy and our high-net-worth clients than some of the initial policy changes. Given the evolving nature of these regulations and their potential financial implications, we are closely monitoring these developments. We encourage you to stay informed and reach out to your advisor for the most up-to-date guidance tailored to your specific situation.

Key Takeaways

• Strategic Use of Tariffs: Trump’s proposed tariffs may aim to address the U.S.’s long-standing trade deficit by promoting domestic production and reducing reliance on imports, using powers under the International Emergency Economic Powers Act.
• Import Substitution as a Model: The article frames tariffs within the theory of Import Substitution Industrialization (ISI) — a strategy typically used by developing nations to grow domestic industries by limiting foreign competition.
• Risks to Free Trade and Economic Efficiency: While tariffs may offer short-term benefits, overuse could undermine free trade, increase consumer costs, and weaken the U.S.’s global economic position in the long run.

Trump’s Tariffs and the International Emergency Economic Powers Act

Since his inauguration on January 20, 2025, President Donald Trump has been promising and threatening to impose tariffs on imports into the United States. These tariffs are being considered under the International Emergency Economic Powers Act (IEEPA) of 1977, a law that allows the president to use tariffs as a tool to counter aggression from another country. And yet, President Trump is considering using this law to pressure not only international rivals and adversaries, but friends and neighbors as well. Is this an economically sound pursuit for the country? What are the historical contexts and possible uses for tariffs as we consider them going forward?

The Economic Value of Free Trade Agreements

As a general matter, economists and policymakers have largely agreed that free trade benefits nations by fostering economic growth and strengthening international relationships. Free trade allows countries to specialize in producing goods and services for which they have a comparative advantage, leading to greater overall productivity and lower total costs. By reducing barriers such as tariffs, trade agreements tend to promote competition, encourage innovation, and provide businesses with access to larger markets. Beyond economics, free trade plays a crucial role in international diplomacy. When countries engage in open trade, their economic interdependence fosters stability and reduces the likelihood of conflict. Trade relationships create mutual incentives for cooperation, making disputes more costly and diplomacy more attractive. Historically, alliances have often been strengthened through trade agreements, as economic ties reinforce strategic partnerships. While no policy is without drawbacks, and certain industries or workers may face short-term disruptions, the long-term benefits of free trade—stronger economies, greater innovation, and improved global relations—have made it the prevailing doctrine among economists and world leaders alike.

How Tariffs Affect Domestic Economies and Global Trade

Despite the broad consensus in favor of free trade, tariffs remain a recurring feature of economic policy. A tariff is a tax imposed by a government on imported goods. By making foreign goods more expensive, tariffs aim to protect domestic industries from competition, encourage local production, and, in some cases, generate government revenue. Historically, tariffs have been wielded as economic weapons, used to punish adversaries or exert pressure in diplomatic disputes. Countries have imposed tariffs to weaken rival economies or to force policy changes, making them a key tool in trade wars. In earlier eras, tariffs were central to mercantilist policies, where governments sought to accumulate wealth by maximizing exports while minimizing imports.

Today, tariffs are widely regarded as counterproductive to global economic efficiency. The World Trade Organization (WTO) was established, in part, to reduce tariffs and prevent protectionist spirals that could destabilize global trade. While some targeted tariffs may be justified for national security or strategic reasons, broad-based tariffs often undermine the very economic benefits that free trade seeks to achieve.

But the world is not such a simple place as the consensus in favor of free trade would have us believe. A key consideration in any trade policy is the balance of payments. Stated simply, the balance of payments is a record of a country’s exports going out, compared to its imports coming in. If a country has more exports than imports, it has a balance of payments surplus. On the other hand, if a country takes in more imports than it has exports, it has a balance of payments deficit. Balance of payment surpluses make a country rich, while deficits can ruin a country’s economy.

The U.S. Trade Deficit: Why It Matters in the Tariff Debate

Since the 1970s, the United States has run a persistent—and at times colossal—balance of payments deficit. This deficit results in a constant outflow of dollars. Such a persistent and tremendous cumulative trade deficit would be lethal to any other country. But in this specific regard, the United States is special. Because oil, commodities, and international debt are largely priced in U.S. dollars, other nations need a steady supply of greenbacks to maintain their positions in the international market. This makes the U.S. dollar the international reserve currency, and this status effectively means that the United States has largely been in the business of exporting currency for the last 50 years.  Countries are eager to receive dollars, leading them to reinvest these dollars into U.S. assets such as Treasury bonds and equities. This dynamic allows the U.S. to sustain its trade deficits without immediate, catastrophic economic consequences. However, relying on the dollar’s reserve status carries risks. If global confidence in the dollar erodes or another currency challenges its dominance, foreign demand for dollars could decline, leading to reduced investment in U.S. assets, higher borrowing costs, diminished economic influence in global trade, and a massive increase to the costs of imports.

Import Substitution Industrialization: Can It Work for the U.S.?

Though it is hard to guess exactly what President Trump is thinking at any given time, this could be the point where tariffs rationally enter the conversation about international trade and balance of payment deficits. Indeed, in response to concerns about trade imbalances and industrial decline, some countries have looked to Import Substituting Industrialization (ISI) as a potential strategy. ISI is an economic theory aimed at reducing dependency on foreign goods by fostering domestic industries. When utilized, ISI has operated by shielding nascent industries from international competition with tariffs on competing imports, allowing the young, domestic industries to grow until they become competitive on a global scale. Tariffs are generally only part of the protection pursued in ISI, which also relies on import quotas and government subsidies that also make foreign goods more expensive and less accessible. But Tariffs play a central role in ISI by making imported goods cost-prohibitive, giving local industries the space to develop without being undercut by established foreign competitors. By creating a captive market for domestic producers, governments hope to accelerate industrialization, create jobs, and diversify the economy.

In terms of the balance of payments, ISI can help correct a deficit by reducing reliance on imported goods, thereby lowering the outflow of the currency. As domestic production scales up, exports may increase, helping to bring the balance of payments closer to equilibrium. While ISI has been successful in some cases, long-term dependence on tariffs can stifle economic growth and limit global competitiveness. In the worst-case scenario, ISI can lead to higher consumer prices and inefficiencies in the long term if domestic firms fail to innovate and improve productivity.

ISI in Developed Economies: A Strategic Case for the U.S.?

ISI is typically associated with developing nations seeking to build domestic industries and reduce reliance on foreign goods. These countries often lack competitive manufacturing sectors and use ISI to jumpstart industrialization. For a world-leading economy like the United States, which already possesses advanced industries and global supply chain integration, ISI may seem like an unusual strategy. However, in certain circumstances—such as national security concerns, strategic industry development, or balance of payments—targeted ISI policies could be effective. If implemented selectively and temporarily, ISI could help the U.S. strengthen key industries without sacrificing the broader benefits of global trade.

Content provided by LBMC Tax expert David Frederick.

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