Tariff reverberations begin to show in economy

The U.S. gross domestic product shrank by 0.3% (on an annual basis) in the first quarter of 2025, as import inventory investment jumped, likely crowding out other economic activity as companies shifted spending to brace for higher trade barriers.

“This will take a while, has NOTHING TO DO WITH TARIFFS, only that he [former President Joe Biden] left us with bad numbers, but when the boom begins, it will be like no other,” President Donald Trump posted on social media April 30, after the first quarter GDP estimate release. “BE PATIENT!!!”

Trump has continued to double down on using tariffs, which have reached their highest average rate in the U.S. in over a century after the imposition of a new universal 10% tariff and other duties in April, to offset tax cuts.

“When Tariffs cut in, many people’s Income Taxes will be substantially reduced, maybe even completely eliminated,” Trump posted on social media on April 27.

Using tariff revenue to supplant income taxes would reverse over a century of policy around how the federal government is funded, though it’s been a consistent message of Trump and his allies. So far new tariffs have raised about $26 billion in March and April. Though a substantial amount of money, that’s far short of the $600 billion annual pace promised by White House Senior Counselor for Trade and Manufacturing Peter Navarro, or to supplant the nearly $5 trillion of overall income tax revenue collected during the FY24 federal fiscal year.

Consumer sentiment levels saw their steepest three-month decline in the monthly University of Michigan survey since the 1990 recession, and multiple regional Fed surveys found declines in manufacturing activity for their areas of the country in April. 

The negative economic headlines create more pressure on congressional Republicans to produce a tax and fiscal package that boosts the economy, and makes up for the tax increase and inflationary effects of tariffs. According to an estimate by the Tax Foundation, the tariffs already implemented this year constitute the largest tax increase (as a measure of GDP) since 1993. If the dozens of country-specific tariffs paused on April 9 go into effect it would become the largest tax increase since the 1960s, according to a separate measure by JPMorgan.

The Trump administration has tied campaign proposals around tax-free overtime and tipped wages, a deduction for auto loans, elimination of the state and local tax deduction cap, and increased incentives for factory and domestic manufacturing. These proposals are, at least to some extent, competing with the multitrillion dollar extension of expiring Tax Cuts and Jobs Act provisions, like the Section 199A qualified business income deduction and expiring personal income tax rates, and the doubled standard deduction for budgetary space in the “mega-bill” tax and fiscal legislation Republicans plan to pass this year. If those TCJA provisions expire it will result in tax increases on every individual taxpayer and most businesses.

The tariffs continue to be a major political issue. A joint resolution to end the national emergency used as legal justification for the 10% global tariff, offered by Sen. Ron Wyden, D-Ore., failed to advance on a narrow 50-49 tally, with Vice President J.D. Vance providing the tie-breaking vote, on April 30. Trump has also threatened to veto resolutions that could undo his tariffs, raising the de facto threshold for congressional votes to undo them to 2/3 supermajority in both chambers of Congress.

On April 23 Democratic attorneys general for 12 states filed suit against Trump and other federal officials over the administration’s novel use of the International Economic Emergency Powers Act in implementing the 10% global tariffs, the 25% tariffs on Canadian and Mexican imports, and 145% baseline tariffs on Chinese imports. The suit is the latest of at least seven legal challenges to the Trump tariffs, with other notable cases being brought by nonprofit organizations funded by conservative-leaning donors.

Whether the challenges will succeed remains unclear. IEEPA is a national security statute that has survived lawsuits over separate issues in the past, generally due to deference from courts to the president’s constitutional role as commander-in-chief. The law has never been used for tariffs, though its legal predecessor was invoked for a 10% global tariff by former President Richard Nixon over a temporary balance-of-payments crisis in the early 1970s.

Given the novel and complex constitutional arguments around the use of IEEPA for tariffs, it could take years for legal cases against the tariffs to play out, although a temporary injunction is possible, if not likely.

In the meantime, negotiations with other countries could lead to some more immediate relief, if the administration reaches agreements it finds politically acceptable. Canadian Prime Minister Mark Carney is due to visit the White House on May 6, following recent parliamentary elections that solidified the new premier’s power, and Trump told reporters negotiations with the Chinese government had begun, a statement disputed by the Chinese Embassy in Washington. However, China did quietly relax some retaliatory tariffs against American products, which still mostly face a 125% tariff rate there. 

There seems to be more administration optimism over the status of talks with India, Japan, and South Korea, according to statements made by Treasury Secretary Scott Bessent during a press briefing on April 29.

Some sort of topline agreements could stave off tariff increases planned for July 9 on products from those countries. But a similar arrangement, known as Phase One, reached with China by the first Trump administration in 2020 drew mixed results, as China only met 58% of the $200 billion purchase agreement key to the deal, according to a review by the Peterson Institute of International Economics. 

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