This piece (previously titled “Trump’s Trade Strategy Takes Shape with Latest EU Trade Deal”) was revised on August 1, 2025, to include updates from the latest U.S. tariff announcements.

A New Framework Takes Shape

The August 1 tariff announcements have clarified the United States’ trade policy, but important details remain unclear. Key questions persist around the definition of transshipment, how countries facing higher tariffs can ameliorate them, and whether these new rates will prove durable over time.

At the same time, the administration has announced framework agreements over the past few weeks with the United Kingdom, China, Vietnam, Indonesia, Japan, and the European Union. The shape of these agreements provides insight into administration objectives and distinguishes this approach from previous trade policy frameworks. The policy structure includes four primary components: (1) uniform and significant tariff rates across most products for each partner—with China as a notable exception and details still emerging for the European Union; (2) retention of higher tariffs on smaller set of strategic industries—including steel and aluminum; (3) acceptance of investment and purchase commitments rather than requiring reciprocal tariff reductions; and perhaps most importantly (4) achieving this significant restructuring of U.S. tariff rates without triggering widespread retaliation from trading partners.

This success in avoiding retaliation likely stems from credible signaling of “escalation dominance”—essentially convincing partners that entering a cycle of economic retaliation would be more costly for them than for the United States. With the picture of U.S. policy now coming into focus, this provides a good opportunity to assess what the economic evidence reveals about these policies and what it means for future policy design.

What Economic Research Actually Shows

Recent research by Ina Simonovska and her coauthors, forthcoming in the Journal of International Economics, provides a framework for evaluating these policies, and the findings are more nuanced than political rhetoric suggests. Tariffs are distortionary, like most taxes, and generally create welfare losses. However, that doesn’t mean they can’t create economic benefits, especially for countries like the United States.

Economic theory has long held that large economies like the United States can potentially extract welfare gains through strategic tariff policy by improving their “terms of trade”—essentially forcing foreign producers to accept lower prices while maintaining access to the U.S. market.

In their work, Making America Great Again? The Economic Impacts of Liberation Day Tariffs, researchers find that under specific conditions, the United States could achieve modest welfare gains from uniform tariff implementation. The study indicates that if designed optimally from the perspective of the United States, tariffs could increase U.S. GDP by 2.2 percent relative to the baseline nontariff scenario, when accounting for supply-chain linkages. However, these findings come with significant caveats that are critical for policy evaluation and future policy development.

The Conditions That Matter

The research identifies three conditions necessary for positive outcomes:

First, tariffs must be uniform across partners to avoid trade diversion effects that hurt the economy. While the tariff would lower U.S. exports, it would reduce U.S. imports by even more—thus reducing the total U.S. trade deficit. However, bilateral deficits with individual trade partners are irrelevant to the optimal tariff design.Second, revenue must be directed toward income tax reduction rather than lump-sum transfers to citizens (recently floated by the administration). Lower income taxes would result in efficiency gains for the U.S. economy and stimulate employment, whereas mailing out identical checks to U.S. households with claims to tariff revenues would result in job loss and would undo all U.S. welfare gains.Third, and most critically, the administration must achieve all of this without triggering retaliation or rebalancing efforts by trading partners.

If optimal retaliation occurs, the analysis suggests U.S. welfare would decline by up to 5.3 percent below pre-tariff levels, creating a classic prisoner’s dilemma scenario wherein everyone ends up worse off. It is also critical to note that even in the non-retaliatory scenario, the unilateral optimal policy would have little impact on the trade deficit, reducing it by about 13 percent.

Assuming the administration intends to keep U.S. tariff rates high—which is not the first-best economic option—there are critical considerations that should inform additional fiscal policy design.

Who Really Pays: Distributional Impacts

While the aggregate benefits of higher tariffs may be positive, there are significant distributional impacts across U.S. consumers that merit careful consideration. Research consistently demonstrates that tariff costs fall disproportionately on lower-income households, who allocate larger budget shares to tradable goods. This regressive impact creates tension with stated policy goals of supporting working-class Americans and highlights the complex relationship between trade policy and domestic inequality.

The effects vary dramatically across sectors as well. Industries that rely heavily on imported inputs that are not easily replaced with domestic alternatives will suffer as a result of these tariffs. Especially if trading partners do not lower their tariffs on U.S. goods, which they have so far largely refused to do, U.S. exporters will face steeper competition selling into global markets as they face higher input costs than their foreign competitors. This will harm small- and medium-sized businesses reliant on export markets worse than their larger multinational competitors, who can shift to selling into foreign markets from production locations in third jurisdictions.

U.S. small businesses will face multiple, compounding challenges created by these tariffs; they will have a harder time selling globally, will face high costs due to greater red tape while importing, and will have less ability to lobby the federal government for targeted relief than their large competitors. At the same time, a large body of research also demonstrates that tariff protection will also insulate some small and inefficient firms from global competition. While this may counteract some of the negative effects on small firms, it will also lead to a more inefficient allocation of capital and an overall less productive U.S. economy overall.

If the administration intends to keep these tariffs, it should think carefully about how to ameliorate these burdens on low-income Americans, small businesses, and U.S. entrepreneurs while also promoting productivity growth, which will be stymied by these policies.

The Revenue Reality Check

The administration has promoted tariffs as a fiscal tool, but the numbers tell a more sobering story. Even under optimistic scenarios without retaliation, tariff revenues from the tariff levels announced on Liberation Day amount to approximately 1.1 percent of GDP—roughly 5 percent of the federal budget. These figures decline substantially if trading partners implement retaliatory measures, potentially falling to 0.7 percent of GDP.

For context, the Congressional Budget Office (CBO) projects that recent tax legislation will increase the deficit by $2.4 trillion over the next decade. According to new CBO estimates, tariff revenues could offset the cost of these tax cuts—but only if the tariffs, currently imposed under emergency authorities, are maintained as-is or formally codified by Congress. Both in terms of scale of potential revenue and in terms of durability, these tariffs, while substantial, still differ considerably from other revenue sources: Corporate income taxes generate approximately 2 percent of GDP annually, while individual income taxes account for roughly 8 percent of GDP.

The administrative complexity of tariff collection adds to another layer of cost. Unlike broad-based taxes, tariffs require extensive customs infrastructure, product classification systems, and enforcement mechanisms that reduce net fiscal benefits.

This same increase in red tape creates particular challenges for small- and medium-sized enterprises navigating the new tariff structure, which often lack the resources to adjust supply chains or absorb cost increases that larger competitors can manage more effectively.

Global Economic Implications: The “Beggar Thy Neighbor” Problem

The gains that the United States can achieve through these tariffs are what economists call “beggar thy neighbor”—meaning they come at the expense of trading partners. Smaller economies heavily dependent on U.S. market access—including Canada, Mexico, Ireland, and several Southeast Asian nations—face welfare losses potentially up to 3 percent, while large trade partners such as Germany could experience up to 1 percent loss from tariff levels of the order of magnitude proposed on Liberation Day.