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President Donald Trump has drawn comparisons to President William McKinley, often referred to as the “Tariff King,” for his strong stance on tariffs. Trump’s recent decision to impose sweeping 25% tariffs on imports from Canada and Mexico has reignited debates over the role of tariffs in economic policy.
As he addressed Congress this week, Trump defended these measures, asserting that they are about “protecting the soul of our country.” His stance marks a significant shift in the traditionally pro-free trade GOP, though concerns remain within the party about the long-term economic impact.
The Three Functions of Tariffs: Revenue, Restriction, and Reciprocity
Historically, tariffs have been used in three primary ways:
- Revenue Generation– Before the introduction of the income tax, tariffs were a major source of government revenue.
- Restriction of Trade – Tariffs can be used to limit imports, protecting domestic industries from foreign competition.
- Reciprocity – Tariffs can be leveraged to negotiate better trade terms with other nations.
McKinley, who was a strong advocate for protectionist (or restriction of trade) policies, championed high tariffs as a way to protect American businesses and workers. The McKinley Tariff of 1890, which raised duties on imported goods to nearly 50%, was one of the most protectionist measures in U.S. history. While it bolstered certain industries, it also led to increased costs for consumers and retaliatory measures from trading partners.
McKinley utilized tariffs as a tool to bolster American manufacturing, and Trump has adopted a similar approach, using tariffs as a means of economic leverage. However, unlike McKinley’s era, today’s global economy is deeply interconnected, making tariffs a more complex tool with widespread ripple effects.
Trade Deficits and the Laffer Curve
The United States currently faces a trade deficit of $918.4 billion in 2024, a 17% increase from 2023. This deficit results from imports ($4,110.0 billion) exceeding exports ($3,191.6 billion), comprising 3.1% of GDP. While Trump views tariffs as a way to correct trade imbalances, economists warn that such measures can lead to higher consumer prices and potential retaliatory tariffs.
Economist Arthur Laffer introduced the Laffer Curve in 1974 to members of President Gerald Ford’s administration, challenging the prevailing belief that higher tax rates would automatically increase government revenue. He argued that excessive taxation discourages business investment and work effort, leading to lower overall tax revenue. Businesses might relocate or find ways to shelter income, while workers may reduce their productivity if taxed too heavily.
Laffer’s theory influenced President Ronald Reagan’s economic policies, particularly Reaganomics, which emphasized supply-side economics and substantial tax cuts. Despite these cuts, total federal tax revenue nearly doubled from $517 billion in 1980 to $909 billion in 1988, supporting Laffer’s argument that lower tax rates can stimulate economic growth and, in some cases, increase government revenue.
The Shift from Tariffs to Income Tax
The Laffer Curve, often referenced in tax policy discussions, suggests that there is an optimal tax rate that maximizes government revenue. If tariffs are too low, they fail to generate sufficient revenue, but if they are too high, they can stifle trade and reduce overall economic activity. Balancing tariffs to maximize benefits without triggering economic slowdowns is a delicate challenge.
McKinley’s reliance on tariffs as a revenue source ended with his assassination in 1901. Under Theodore Roosevelt, the groundwork for the federal income tax was laid, ultimately leading to the ratification of the 16th Amendment in 1913. This marked a fundamental shift in how the U.S. government funded its operations, reducing reliance on trade restrictions.
Market Reactions and the Importance of Diversification
Trump’s tariff policies are disrupting long-standing economic relationships, particularly within North America. The imposition of tariffs on Canadian and Mexican imports raises production costs for U.S. manufacturers that rely on integrated supply chains. While some businesses may relocate to the U.S. to avoid tariffs, the overall effect is still unknown.
Markets have responded with increased volatility (Read about 5 Key Takeaways from the Trump Tariff Market Correction here), as investors digest the potential consequences of disrupted trade flows. Historically, stocks have served as a hedge against inflation, as companies grow revenues and increase dividends over time. However, inflationary pressures create a tug-of-war effect:
- Companies initially raise prices to maintain profit margins, supporting stock prices.
- When consumers resist further price hikes, companies absorb higher costs, leading to margin compression and weaker stock performance.
- Economic uncertainty and potential recessions add further volatility to the market.
Despite these fluctuations, history has shown that staying invested in a diversified portfolio remains a prudent strategy. Tariff-driven market disruptions, while unsettling, reinforce the importance of patience and long-term investment discipline.
How to Stay Resilient
Trump’s tariff policies echo those of McKinley, but today’s globalized economy makes their effects more complex. With trade deficits at historic levels and market volatility increasing, investors must remain focused on diversification and long-term growth. Understanding the historical context of tariffs, taxation, and economic policy can provide valuable insights into navigating the current landscape. As history has shown, economic disruptions come and go, but a disciplined approach to investing remains the best path forward.
If you’re concerned about your portfolio or would like a second opinion, we’re here to help. At Intelligent Investing, our passion is to minimize financial stress and maximize lives. Reach out to us to learn how we can help you navigate market volatility and build a strategy aligned with your long-term financial goals.
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