When Donald Trump surprised pollsters by winning the 2016 presidential election, investors were unsure about his economic policies. During his first year in office, I wrote a book analyzing them to assess how they would impact financial markets.
One of the main findings was that Trump’s signature legislation, the Tax Cut and Jobs Act of 2017, would have a favorable impact. The reason is that it lowered the marginal corporate tax rate from 35 percent to 21 percent, bringing it in line with other industrial countries and reducing incentives for multinationals to outsource jobs.
In comparison, I maintained that increasing tariffs on goods from China and other countries would invite retaliation and heighten financial market volatility.
These findings were largely validated. The U.S. stock market rose steadily until Trump launched a trade war with China in spring 2018. Thereafter, it fell at one point by 15 percent and did not surpass its previous peak until mid-2019, when U.S.-China trade tensions lessened.
While inflation and unemployment were low during Trump’s presidency, many economists believe the policies Trump espouses are more extreme and threaten the U.S. and global economy. The Wall Street Journal’s latest survey of economists showed the majority expect Trump’s policies to lead to higher inflation and interest rates and larger budget deficits.
Trump’s tax proposals include lowering the marginal corporate tax rate to 15 percent, exempting Social Security benefits, overtime pay and workers’ tips from taxation and reinstating the former State and Local Tax or SALT deduction. On the tariff front, he is calling for tariffs of 60 percent on Chinese goods and 10-20 percent on other imports.
The combination of tax cuts and tariff increases would widen the federal budget deficit substantially, according to the Committee for a Responsible Federal Budget. It estimates the increase would be about $7.5 trillion over the next decade, which is more than double the estimated increase for Vice President Harris’s plans.
The Wall Street Journal Editorial Board offered a harsh assessment of “Trump’s new tax giveaways” on the grounds they violate a core principle of fair taxation, which is that similar income should be treated similarly. The Journal’s editors contend that by narrowing the tax base, the proposals imply that tax rates would have to be higher to limit the adverse impact on the budget deficit.
Financial markets have not reacted to them, because the election is very close and investors are waiting for the outcome. Investors are also aware that the tax proposals have not been vetted. If Republicans were to gain control of Congress, they would likely focus on extending the Tax Cuts and Jobs Act and let the other proposals fall by the wayside.
By comparison, Trump’s passion for raising tariffs has been a core belief of his since the 1980s when Japan ran record trade surpluses with the U.S. and jobs in manufacturing began to shrink. Since then, his views on tariffs and China have been reinforced by Robert Lighthizer, who has hardened his stance on China since he served as Trump’s U.S. trade representative.
In an interview with Bloomberg’s John Micklethwait this week, Trump defended his plan to dramatically increase tariffs, saying tariffs were for the “protection of the companies that we have here and the new companies that will move in.”
If Trump wins the presidency, some of his tariffs could be adopted fairly quickly because Congress has delegated extensive tariff-setting authority to the president. CNBC cited a Piper Sandler report last week that said Lighthizer told investor groups that Trump could unveil his tariff proposals soon after taking office, and they could be in place by the end of 2025 if not sooner.
Some legal experts contend Trump could use the Trade Act of 1974 or the International Economic Emergency Act of 1977 to justify higher tariffs on China. However, there is more uncertainty about whether he could follow through with a tariff hike of 10 to 20 percent on other imports, as he could face court challenges or a congressional response. In that case, the process would be drawn out, leaving investors uncertain about the outcome.
Kimberly Clausing and Maurice Obstfeld of the Peterson Institute for International Economics cite findings that Trump’s tariffs in 2018-2019 were costly to consumers, harmed U.S. export competitiveness and did not create a manufacturing renaissance. They concluded the negative effects of his latest proposals would be considerably greater than the initial round because they would impact virtually all U.S. imports versus 10 percent of imports.
The Tax Foundation estimates that duties collected would approach 18 percent of the total value of U.S. imports, the highest level since the 1930s.
The biggest risk is that a 60 percent tariff would prompt China to retaliate. It could do so by increasing tariffs on U.S. goods, harassing companies operating in China, intensifying its campaign to discourage Chinese people from buying U.S. brands and limiting the export of critical minerals.
My bottom line is that Trump’s tariffs would be the most extreme since the Smoot Hawley Tariff in 1930. They pose a significant threat to the global economy because of how far-reaching they are, the odds of implementation and the potential for widespread retaliation.
Should a new trade conflict break out, investors should be prepared for a spike in financial market volatility that is considerably greater than during the initial round of the U.S.-China trade war.
Nicholas Sargen, Ph.D., is an economic consultant and is affiliated with the University of Virginia’s Darden School of Business. He has authored three books including “Investing in the Trump Era: How Economic Policies Impact Financial Markets.”