Reciprocal Tariff Calculations
TLDR
This report documents “reciprocal tariff” framework to address U.S. trade deficits, proposing tariffs ranging from 0-99% (averaging 20-41%) based on the assumption that bilateral deficits indicate unfair trade practices. The approach contradicts mainstream economic theory, faces WTO compatibility issues, and could trigger retaliatory tariffs, higher consumer prices, supply chain disruptions, and global economic slowdown. The mathematical model has significant flaws and overlooks key factors in manufacturing decline such as automation and productivity changes.
This report outlines a plan for implementing “reciprocal tariffs” aimed at balancing bilateral trade deficits between the U.S. and its trading partners. The policy represents a significant shift in U.S. trade strategy under the Trump administration.
The executive order establishes a framework for calculating tariffs based on the premise that persistent U.S. trade deficits are caused by unfair trade practices and barriers from other countries. The order proposes tariffs ranging from 0% to 99%, with average rates of 20% (unweighted) and 41% (import-weighted).
Key Assumptions:
- Trade deficits should naturally balance over time
- Persistent deficits indicate unfair trade practices
- Tariffs can directly reduce imports and balance trade
The mathematical model is, essentially, hogwash.
The proposed tariff system could trigger several economic challenges:
- Retaliatory tariffs from trading partners would likely follow, potentially escalating into trade wars
- Consumer prices would increase despite the low assumed passthrough rate
- Supply chains would face significant disruption as companies adjust to new cost structures
- Global economic growth could slow as trade barriers rise
Disputed Claims:
The report attributes U.S. manufacturing decline primarily to trade imbalances, citing the closure of 90,000 American factories and loss of 6.6 million manufacturing jobs since 1997. However, this overlooks other significant factors in manufacturing decline:
- Automation and technological change
- Productivity improvements
- Shifts in consumer preferences
- Domestic policy choices
This approach represents a significant departure from decades of U.S. trade policy that has generally favored reducing trade barriers. The high tariff rates proposed (up to 99%) would be the most aggressive U.S. trade action since the Smoot-Hawley Tariff Act of 1930, which economists widely consider to have worsened the Great Depression.
The model’s assumption that bilateral trade should balance with each individual country contradicts mainstream economic theory, which holds that overall trade balance matters more than bilateral balances.
The implementation of such broad tariffs would face several practical challenges:
- WTO compatibility issues and potential legal challenges
- Administrative complexity in applying different rates to different countries
- Difficulty in preventing transshipment (routing goods through low-tariff countries)
- Economic adjustment costs as industries adapt to new trade patterns
The report acknowledges some of these challenges, noting that “higher minimum rates might be necessary to limit heterogeneity in rates and reduce transshipment.”
Executive Summary
Reciprocal tariffs are calculated as the tariff rate necessary to balance bilateral trade deficits between the U.S. and each of our trading partners. This calculation assumes that persistent trade deficits are due to a combination of tariff and non-tariff factors that prevent trade from balancing. Tariffs work through direct reductions of imports.
Reciprocal tariff rates range from 0 percent to 99 percent, with unweighted and import-weighted averages of 20 percent and 41 percent.
Introduction
To conceptualize reciprocal tariffs, the tariff rates that would drive bilateral trade deficits to zero were computed. While models of international trade generally assume that trade will balance itself over time, the United States has run persistent current account deficits for five decades, indicating that the core premise of most trade models is incorrect.
The failure of trade deficits to balance has many causes, with tariff and non-tariff economic fundamentals as major contributors. Regulatory barriers to American products, environmental reviews, differences in consumption tax rates, compliance hurdles and costs, currency manipulation and undervaluation all serve to deter American goods and keep trade balances distorted. As a result, U.S. consumer demand has been siphoned out of the U.S. economy into the global economy, leading to the closure of more than 90,000 American factories since 1997, and a decline in our manufacturing workforce of more than 6.6 million jobs, more than a third from its peak.
While individually computing the trade deficit effects of tens of thousands of tariff, regulatory, tax and other policies in each country is complex, if not impossible, their combined effects can be proxied by computing the tariff level consistent with driving bilateral trade deficits to zero. If trade deficits are persistent because of tariff and non-tariff policies and fundamentals, then the tariff rate consistent with offsetting these policies and fundamentals is reciprocal and fair.
Basic Approach
Consider an environment in which the U.S. levies a tariff of rate τ_i on country i and ∆τ_i reflects the change in the tariff rate. Let ε<0 represent the elasticity of imports with respect to import prices, let φ>0 represent the passthrough from tariffs to import prices, let m_i>0 represent total imports from country i, and let x_i>0 represent total exports. Then the decrease in imports due to a change in tariffs equals ∆τ_i*ε*φ*m_i<0. Assuming that offsetting exchange rate and general equilibrium effects are small enough to be ignored, the reciprocal tariff that results in a bilateral trade balance of zero satisfies:
Parameter Selection
To calculate reciprocal tariffs, import and export data from the U.S. Census Bureau for 2024. Parameter values for ε and φ were selected. The price elasticity of import demand, ε, was set at 4.
Recent evidence suggests the elasticity is near 2 in the long run (Boehm et al., 2023), but estimates of the elasticity vary. To be conservative, studies that find higher elasticities near 3-4 (e.g., Broda and Weinstein 2006; Simonovska and Waugh 2014; Soderbery 2018) were drawn on. The elasticity of import prices with respect to tariffs, φ, is 0.25. The recent experience with U.S. tariffs on China has demonstrated that tariff passthrough to retail prices was low (Cavallo et al, 2021).
Findings
The reciprocal tariffs were left-censored at zero. Higher minimum rates might be necessary to limit heterogeneity in rates and reduce transshipment. Tariff rates range from 0 to 99 percent. The unweighted average across deficit countries is 50 percent, and the unweighted average across the entire globe is 20 percent. Weighted by imports, the average across deficit countries is 45 percent, and the average across the entire globe is 41 percent. Standard deviations range from 20.5 to 31.8 percentage points.
References
Boehm, Christoph E., Andrei A. Levchenko, and Nitya Panalai-Nayar (2023), “The long and short of (run) of trade elasticities, American Economic Review, 113(4), 861-905.
Broda, Christian and David E. Weinstein (2006). “Globalization and the gains from variety,” Quarterly Journal of Economics, 121(2), 541-585.
Pujolas, Pau and Jack Rossbach (2024). “Trade deficits with trade wars.” SSRN.
Simonovska, Ina and Michael E. Waugh (2014). “The elasticity of trade: Estimates and evidence,” Journal of International Economics, 92(1), 34-50.
Soderberry, Anson (2018). “Trade elasticities, heterogeneity, and optimal tariffs,” Journal of International Economics, 114, 44-62.