Today was only the third trading day since the Liberation Day announcement, although to many investors it may feel like an eternity has passed.
Stocks fluctuated wildly today but ended the session generally even, as investors looked for signs of hope that a tariff-induced global recession does not have to be our fate.
International trade is a complex subject. There are nuances to the topic and competing perspectives that are worth debating.
What is not really up for debate, however, is the great extent to which the global economy—including the American economy—relies on supply chains from all over the world.
Understanding the market crash
The stock market has collapsed because the tariffs that Trump announced on Liberation Day were seen as exceedingly high.
Whether or not tariffs provide a good way to conduct economic policy is an interesting question. We have in fact written and spoken positively about tariffs as a potential tool to advance American interests.
Tariffs, or the threat of tariffs, can be applied, almost like sanctions, to encourage or discourage certain behaviors.
As the largest economy in the world, not to mention the strongest military, the U.S. has a unique ability to exercise its leverage over other countries with tariffs.
There is also something to be said for using tariffs to conduct industrial policy.
To be fair, the purist free trade paradigm may not adequately address certain economic and military security concerns or issues like supply chain resilience.
There are many good reasons that a country would want to use protectionist strategies to maintain a certain level of industrial and agricultural autonomy, even if it is not the most efficient producer.
There is potentially even something to be said about countering the protectionist strategies of other countries.
But is the Trump team overdosing on tariffs?
President Trump has said of his tariff plan that “sometimes you have to take medicine to fix something.” The analogy he is drawing is that medicine can be difficult going down, but it is ultimately good for you.
The problem arises when you consume too much medicine. This can be lethal.
From the stock market’s perspective, the core problem with the tariffs as announced last Wednesday is that they are too large. Way too large.
It may be helpful to put in perspective just how large a tariff increase has been proposed by Trump. Prior to the announcement, and mainly as a result of tariffs announced in his first term, the Effective Tariff Rate was approximately 2.5%.
The Effective Tariff Rate is a simple calculation. It represents total revenue generated by tariffs divided by the total value of all imports from all countries. Essentially, it is an average tariff rate applied to all foreign goods.
Markets were actually edging up higher as soon as the Trump tariff schedule was announced last Wednesday because it initially looked like tariffs would be in the 10% range. While this meant a four-fold increase from prior levels, it was considered manageable and therefore bullish.
Stocks began to nosedive once it became clear that much higher tariff rates would be applied to many countries, including important U.S. trading partners.
The methodology used to calculate tariffs was also disconcerting since it was linked to each country’s trade deficit. This was problematic because certain countries, like South Korea, already apply very low tariffs to U.S. goods.
If their tariffs were already close to zero, what could these countries even offer Trump to reduce their tariff burden?
A massive tax hike
Following the Liberation Day announcement, the Effective Tariff Rate has been widely estimated around 22% to 23%. This is nearly a ten-fold increase.
In revenue terms, only about $80 billion of tariffs were collected in 2024. If tariff rates skyrocket as planned, this number can grow as high as $700 billion, according to Peter Navarro, Trump’s trade adviser and possibly the key official driving this whole strategy.
There are some question marks, however, around Navarro’s estimates, which are based on some $4 trillion of goods and services that are imported annually.
Actual collections would depend on the extent to which the value of imports declines as a result of the high tariffs. Like any tax, the higher the tax rate that is applied to economic activity (in this case foreign imports), the more that activity is discouraged.
While $80 billion a year in tariffs is not chump change, when it grows to $700 billion, we are talking about a significant tax hike.
And make no mistake, tariffs are indeed a tax that is paid by American consumers who purchase imported goods.
There are barely any companies that can afford to absorb tariffs of the magnitude that are being discussed. These tariffs will be almost entirely passed through in the form of higher prices to customers who still choose to purchase the foreign items affected.
$700 billion in perspective
Federal tax receipts in 2024 were approximately $4.9 trillion. About half of this came from personal income taxes. Payroll taxes are the next largest segment (around 30%). Corporate income taxes are less than $500 billion (around 10%).
If tariffs raise $700 billion, that amounts to a 20% tax hike on the American public.
It is true that Trump has announced his intention to pursue income tax cuts that would offset the revenue raised through tariffs. But in the meantime, we are looking at a substantial revenue transfer from the private sector to the public sector that will go into effect in short order.
Part of the market’s adverse reaction to the tariffs is the demand shock that this tax hike represents.
Imagine everyone’s personal income tax burden was suddenly raised by more than 25% overnight ($700 billion relative to personal income tax collections of approximately $2.5 trillion).
Investment banks like Goldman Sachs and JPMorgan are talking about elevated recession risk in large part because of this giant tax increase on American consumers.
We also see recession risk getting priced in by participants on the online prediction platform Polymarket. Ever since tariff talk picked up in mid-February and stocks began to slide, the expected probability of a recession started to drift upwards and now sits above 60%.
