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CBO Warns of Negative Impact on GDP and Prices if Trump’s Tariff Policy Continues

Tariff increases and other trade barriers imposed in 2018 by the Trump administration could lower real U.S. gross domestic product (GDP) 0.1 percent through 2029 and result in price increases on consumer goods, according to a new report from the Congressional Budget Office (CBO).

The CBO said changes to trade policy, such as the recent increases in tariffs on certain imported goods from China, could also affect economic activity by influencing domestic prices, trade flows and real output and income. In addition, the report said, “fiscal policy and tariffs (which are a form of tax) both have important implications for federal deficits and debt, which in turn are key determinants in CBO’s projections of national saving and borrowing from abroad.”

The CBO analysis said strong product and labor markets are seen putting upward pressure on interest rates and price and wage inflation. The rate of inflation, as measured by the price index for personal consumption expenditures (PCE), is projected to modestly exceed the Federal Reserve’s long-term goal, causing disruption to Fed fiscal policy and decision-making.

In the short term, CBO projects that the new tariffs will raise the prices paid by U.S. consumers and businesses directly by making imported goods more expensive and, indirectly, by making the goods and services produced with imported goods more costly.

“The magnitude of those price changes and therefore the extent of the negative impact on domestic output depends on how much of the increase in costs is absorbed by foreign producers and how much of those costs is passed along to domestic consumers and businesses,” CBO said.

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The report said foreign producers will likely absorb more of the tariffs’ costs in the near term as they initially try to maintain market share, but domestic consumers and businesses will bear more of the costs over time.

“Moreover, import tariffs can increase prices if domestic producers raise the prices they charge for domestic goods that compete with the imports subject to new tariffs,” CBO said.

CBO’s assessment did note that the inflationary effects of new tariffs on domestic prices will be dampened over time as imports are diverted to countries whose goods are not subject to tariffs. This has begun to be seen in apparel sourcing, as China has lost market share to its Asian neighbors and other suppliers as companies have diversified to reduce their production exposure during the U.S.-China trade war. Although, experts have noted that lower prices aren’t necessarily the outcome because few countries have the vertical raw material and manufacturing capacity that exists in China.

CBO estimated that new tariffs will result in net increases in the price index for PCE of 0.1 percent and 0.5 percent for private investment by 2022.

“Like other price increases that result from taxes, those higher prices will reduce consumer spending by diminishing the purchasing power of consumer income and will reduce investment by making capital goods more expensive,” the CBO said.

The report noted that Trump’s tariffs were imposed on 12 percent of U.S. imports in 2018, including washing machines, solar panels, and steel and aluminum products from most countries, as well as about half of U.S. imports from China, mostly intermediate and capital goods. In response, U.S. trading partners retaliated with their own tariffs on 9 percent of all U.S. goods exports, primarily industrial supplies and materials, and agricultural products.

If these changes are permanent and if threatened 10 percent to 25 percent additional U.S. tariffs on $200 billion worth of Chinese goods do not take effect on March 1, CBO projects that the recent changes will reduce U.S. real GDP about 0.1 percent by 2022. Specifically, CBO estimates decreases of 0.1 percent in real consumption, 0.3 percent in real private investment, and 0.5 percent in real U.S. exports.

The report didn’t project the potential impact if the new tariffs, which would likely include a broad swath of apparel and footwear products, are imposed.

The report added that the recent changes in trade policy “have increased concern that they may signal a fundamental shift in global trade policy and an increased risk of the erosion of the rules-based global trading system that would significantly increase the risks associated with investment in the U.S. and abroad.”