Kyle Pomerleau explores the impact of tariffs on investment in American business.
Over the past several months, several commentators have referred to tariffs as a consumption tax. … There is a certain intuition behind this—an excise tax is levied on the purchase of imported goods, many of which are final consumer goods. However, there is an important difference—tariffs apply to capital goods like machinery and equipment used by businesses. This means that tariffs, unlike consumption taxes, can penalize investment.
The structure of consumption taxes can vary, but they all share a key feature—they do not apply to saving and investment. For example, value-added taxes apply to all business sales but provide firms a refund for any tax paid on purchases from other businesses. Retail sales taxes exempt all business-to-business transactions and apply only to sales to end consumers. The Hall-Rabushka Flat Tax exempts capital income earned by individuals and excludes investment from the base of the business tax by allowing firms to fully deduct investment costs.
Tariffs, in contrast to consumption taxes, apply to both consumer goods and business inputs, including capital goods. Capital goods or fixed assets are purchased by businesses as investments and are used in their production process. For example, a truck is an investment when purchased by a transportation company. Tariffs can either apply directly to imported capital goods or apply indirectly by increasing the cost of inputs used to manufacture capital inputs in the United States.
Tariffs that raise the relative price of capital goods distort investment by increasing its cost much like an income tax. A higher relative price for capital goods means that firms need to earn a higher pre-tax return to provide the same after-tax return for shareholders. This can make certain projects no longer viable, reducing overall investment.
