Understanding tariffs and how they may affect you

The US has had tariffs since the Tariff Act of 1789. They are not new.

Free Trade in North America is relatively new. We first crafted a Canada US Free Trade Agreement (CUSFTA) in 1988. It was then followed up by the North American Free Trade Agreement (NAFTA) in 1994 and finally that was replaced by the United State-Mexico-Canada Agreement (CUSMA). Prior to that we had tariffs. After that we had tariffs. They are not new. Not one of the agreements eliminated all tariffs, but they each played a part in reducing tariffs throughout North America.

Also, each time, but especially with the first agreement, there was skepticism and fear in spite of clear, compelling and known long-term economic benefits. In fact, during the 1988 Canadian election, more votes were cast for anti-free trade parties than pro parties.

I point the above out only to make it abundantly clear that we have lived with tariffs for a long time. They are not something to be feared. Yes – in the long-run they are negative. That’s why there has been a global move to lower them for years. But we’ve had them all along and we can live with increases in them “if we have to” as Red Green would say.    

In the long haul, free trade benefits both weaker and the stronger economies due to something called “comparative advantage”. In short, you may be better at making widgets A and B than I am, but if I make the ones that I am comparatively (or relatively) better at, then we will both benefit. Maybe that’s an article for another day, but for now, just trust me: free trade, good; tariffs, bad. Or don’t trust me. Just take a course on economics.

I heard that, similar to what happened with Brexit, even though Trump campaigned on increasing tariffs, it was only once he started sabre-rattling about tariffs that people stood up and took notice and for a while the most common google search was “what are tariffs?”. Today, we are going to attempt to answer that question.

In short, a tariff is a tax paid by the exporter on goods being exported into a nation. For example, if I want to sell widgets in the US, and a tariff applies to my widgets, then I will have to pay a tax when I export them into the US. If the tariff is 100% and my widgets are worth $100 when I sell them to someone in the US, then I will have to pay a $100 tax when I export them. So, guess what? I can’t afford to sell them for $100 anymore. In order for me to keep my normal profit margin I will have charge $200. So, the end consumer in the US will likely also pay double.

Clearly that’s not good for the consumer. But it’s also not good for the producer as it will make it harder for them to sell into the US. For competitive reasons they may need to eat some of that tariff cost, but in almost all cases they can’t afford to eat it all, so their sales and their profits will go down. And that probably means laying off some Canadian workers.

Note that the reverse is true for reciprocal tariffs that we put on specific goods coming into Canada.

On both sides of the border, ultimately tariffs will lead to…

• Inflation – higher costs to consumers. Since producers will have to charge more to offset the taxes, consumer will have to pay more.
• Lower profits to companies – as they will likely not be able to pass on the entire cost of the tariffs to consumers.
• Layoffs – lower profits means that companies will need to cut costs.
• Higher government tax revenues – at least in the short term – as producers will have to pay extra taxes on goods exported into the US (and Canada).

It’s interesting that the only winner here (even if it’s only for a short time, as businesses like people change their behaviour to reduce taxes) is the government. Well, I guess that’s not entirely true. There will be certain industries on both sides of the border that will benefit from tariffs. Where two companies are relatively equal, the company in the country that has the highest tariff will likely benefit (at least on a temporary basis) as their competitors will face higher costs.

Think about it like this. You are widget shopping. It doesn’t matter what the widget is. It could be a faucet or a car or anything else for that matter, but your decision-making process is likely to go something like this:

You like widget A more than widget B and they used to be an equal price, so it was a no-brainer. You would buy the one you liked the most: widget A. But now, because widget A is made in the US and there is a 25% reciprocal tariff on that, it costs 25% more than widget B. Now, it’s no longer a no-brainer. Now, you have to think about whether you like it more enough to pay that extra 25%. Some people will like it enough that they will still buy it at the higher price. Some might not. The manufacturer may decide that they are willing to cut their price by 5 or 10 percent in order to get more sales, but they certainly won’t reduce it to the point where they are losing money, so that option is limited.

Multiply these decisions by many, many millions, both on the consumer side and the manufacturing side, and you can see that on a micro level it’s impossible to know exactly what will happen. But on a macro level, without a shadow of doubt, we know: higher prices, lower profits, temporary higher tax revenue.  

That’s tariffs and their consequences in a nutshell. Tariffs (and their consequences) are not the end of the world. And many of the consequences won’t be immediately felt. But it will happen. Be prepared for higher prices.

For more information on this topic, my son and I recently aired a podcast episode where we discuss tariffs. Check out the link to our Retire in BC podcasts Retire In BC podcast.

“A perverse person stirs up conflict…”

• Proverbs 16:28 (NIV)

Arnold Machel lives, works, and worships in the White Rock/South Surrey area. In 1995, he founded Visionvest Financial Planning & Services with the dual goals of “effecting positive financial change” and assisting clients to “Invest with Vision”. Since that time Visionvest has received numerous recognitions, including being voted in the top three in the Best Investment/Financial Advisor category by Peace Arch News readers for the past four years in a row.

Arnold has held the Certified Financial Planner® designation since 1998 and has served on many boards, currently sitting on the board of Abundance Canada (formerly the Mennonite Foundation of Canada), a national charity focused on helping Canadians give generously. He is currently a co-host with his son, Ben, on the popular monthly Retire In BC podcast.

Questions and comments can be directed to him at dr.rrsp@visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.