The United States’ burgeoning $38.6 trillion national debt faces a significant long-term threat from broad-based tariffs, according to Kent Smetters, faculty director of the Penn Wharton Budget Model. Smetters characterizes these tariffs not as industry protection, but as a “dirty value-added tax,” asserting they inflict substantially more economic damage than traditional tax increases. This perspective challenges the common narrative surrounding the imposition of tariffs, particularly those enacted or proposed by figures like Donald Trump.
Economists typically view a uniform, flat VAT as an efficient method for government revenue generation, primarily distorting choices between immediate spending and future savings. However, Smetters distinguishes tariffs as a “dirty” variant because their targeted nature creates widespread inefficiencies. By focusing on specific goods, tariffs compel consumers and businesses to alter their behavior in economically detrimental ways to circumvent the added cost. This selective application stands in stark contrast to the broad economic impact of a standard VAT.
A critical misunderstanding, Smetters argues, lies in the assumption that tariffs primarily impact finished goods. His analysis reveals that approximately 40% of U.S. imports consist of intermediate inputs, not products ready for store shelves. These inputs are vital components used by American companies to manufacture their own products. Consequently, tariffs effectively become a tax on American producers, elevating their operational costs and undermining their global competitiveness. Smetters contends that this reality directly contradicts the notion of tariffs being “pro-American,” suggesting they actively harm domestic manufacturers.
Consider companies like Deere, which has repeatedly quantified the severe financial implications of tariffs. The company projects roughly half a billion dollars in tariff-related costs for fiscal year 2025, escalating to an estimated $1.2 billion hit in 2026. Management has explicitly cited tariffs on metals and specific imported components as sources of “margin pressures” and reduced operating profits, even when overall revenue holds steady. In response, Deere has been forced to re-evaluate and renegotiate supply contracts, and even consider shifting parts of its sourcing and production footprint to mitigate exposure to these increased input costs. Smetters emphasizes that the U.S. economy benefits more from companies like Deere focusing on high-margin intellectual property rather than becoming entangled in the low-margin production of basic components like screws or steel strips, which tariffs on inputs effectively penalize.
While the immediate economic impact of tariffs might appear manageable, perhaps a modest 0.1% reduction in GDP in the first year, the long-term projections are considerably more concerning. Penn Wharton Budget Model projections indicate a cumulative GDP reduction of approximately 2.5% over three decades. This decline is largely driven by a substantial “feedback effect” on the U.S. national debt. As American companies become less efficient due to tariff-induced costs and the government continues to float more debt, global investors are likely to demand a higher return, or risk premium, to hold U.S. Treasuries. This dynamic suggests that the tariff issue is deeply intertwined with the broader national debt crisis.
Smetters posits that the U.S. faces a tangible risk of mirroring Japan’s economic trajectory, a scenario macro analysts like Societe Generale’s Albert Edwards often highlight. Japan has been allocating upwards of 25% of its revenue to interest payments since its stock market bubble burst in the early 1990s. The U.S. is projected to pay $1 trillion in interest payments next year, a figure that continues to climb. To underscore the inefficiency of tariffs, Smetters draws a comparison to a hypothetical increase in the corporate income tax, which is generally considered among the least efficient methods for revenue generation. He estimates that to raise the same amount of revenue as the proposed tariffs, the corporate tax rate would need to rise from 21% to 29%. Yet, the economic damage wrought by tariffs would be an estimated 2.5 times greater than that corporate tax hike, an outcome Smetters finds particularly striking.
