By Carl Tannenbaum

Tariff talk has been at a fever pitch for the past three months. Its dominance of the news cycle has crowded out discussion of other important economic issues, such as the sustainability of America’s national debt.  As the U.S. Congress focuses on the nation’s finances, though, tariffs will still be in the headlines.  Linkages between trade and fiscal policy will make it difficult to reach equilibrium in either arena.

With thin margins in both the House and the Senate, Republicans are relying a reconciliation process to pass their budget initiatives. The rules surrounding reconciliation place limits on how annual deficits can evolve over a ten-year horizon.

The baseline projection used in this process has typically been based on “current law.”  Under this perspective, revenue and spending follow paths set out in legislation. If tax preferences are scheduled to sunset, then government receipts would be forecast to rise.  As well, tariff revenues generated by executive orders and not Congressional actions would not count in the calculations.

This time around, however, the Senate Budget Committee declared that the baseline projection would follow “current policy.”  This approach assumes that the 2017 tax cuts are permanent, and thereby removes the statutory requirement to offset the cost of extending them.  With the change of one word, legislators approved a $4 trillion increase in the national debt over the next decade.

The move was controversial in the court of public opinion, with the nonpartisan Committee for a Responsible Federal Budget calling it a “disgrace.”  Fiscal conservatives in Congress will have the opportunity to register their concerns in the coming weeks, as the reconciliation bill advances.

Getting budget legislation passed is one matter.  Having it pass muster with investors is another.  As we discussed earlier this year, bond markets have periodically expressed displeasure with the accumulation of sovereign debt. A reconciliation without sufficient discipline may prompt a back-up in interest rates.

Tariff revenues are being touted as a tonic to allay those concerns.  Determining how large of a revenue boost will be derived from this source is the product of many factors:

a)   How large tariffs will be, against what goods, for what duration.  These are still very much up in the air.

b)   The degree to which manufacturers will re-shore or shift production to lower-tariff locales.

c)   The degree to which consumers substitute away from tariffed products, or simply defer purchasing them.

d)   The potential for reduced demand for imports that would result from tariff-induced declines in economic growth. This would include the impact of retaliatory actions taken by other countries that would raise prices, reduce real incomes and hinder consumption.

Sorting this all out requires some very intricate calculations, and estimates vary widely.  The Peterson Institute recently made an attempt at this quantification. Interestingly, the results suggest that higher tariffs may produce lower levels of revenue if they invite commensurate retaliation from U.S. trading partners.  Gross or net, the Peterson estimates stand in contrast to the upper bound of $600 billion to $700 billion per year projected by White House trade advisor Peter Navarro.

Officially or viscerally, incorporating tariff revenue into budget considerations raises two risks.  First, revenue projections which prove overly optimistic would leave much deeper-than-expected annual deficits.  And secondly, counting on tariff revenue to keep the budget in line would make it much harder for the United States to lower tariffs as part of trade negotiations.

As much as we might like to put tariffs to the side, even briefly, they seem to creep into almost every policy conversation. The uncertainty they have created, and the outcomes they are driving, will continue to dominate our attention.