What Can We Learn About the Costs and Benefits of Tariffs from a Trade Model?

In this article, we quantify the costs and benefits of tariffs based on a modern trade model. This model predicts that in the case of unilateral tariffs set by the U.S., a modest across-the-board increase in tariff rates can generate a net positive effect on consumption. This occurs when the tariff revenue collected exceeds the output losses caused by resulting distortions and higher domestic prices. The model predicts a peak net gain in consumption equivalent to 0.3% of real gross domestic product (GDP) with a 19.7% unilateral tariff increase, under the assumption that trade partners to the U.S. will not retaliate. However, if foreign countries respond with retaliatory tariffs, the resulting decline in demand for U.S. exports causes an output loss that outweighs the revenue gains. In the long run, as firms and workers reallocate resources across sectors, the model predicts that both the positive and negative effects of tariffs are lower.