What bad news and then good news and then some bad news.
Bad news
On January 21, on his first full day at the office, President Trump threatened To impose a rate percentage of 10% on the input from China. His beef is that ‘China’, whatever that means (Cue Co-Blogger Pierre Lemieux), sends to Mexico chemical ingredients (precursorchemicals) that are used to make fentanyl.
I was a bit surprised by this – not that Trump did it, but that the rate he proposes is “only” 10 percent. Why was I surprised? During the campaign he threatened to impose a 60% rate on Chinese import. Ten percent is only a sixth of 60%. Moreover, he threatens 10% on Chinese input and at the same time threatens no less than 25% rate percentage at the import from Mexico and Canada.
Good news
There is good news here. The damage caused by a rate of 10% is not 1/6 of the damage caused by a rate of 60%. It is only 1/36.
How do I get that? There is one Basic statement in EconomyOne that I taught my students with simple algebra, who says that the deadweight loss of a tax is proportionate, not for the tax rate, but for the square of the tax rate. If Trump would impose a tax rate of 60%, the deadweight loss (DWL) would be 36 times the DWL of a tax rate of 10%.
The loss of deadweight is the loss of consumer surplus and the producer surplus of a tax.
Bad news
It is also important to note that the import of goods from China was around $ 440 billion. The import of goods from Canada and Mexico was approximately $ 410 billion (Canada) Plus around $ 500 billion (Mexico) for a total of more than $ 900 billion. In other words, the import of goods from Canada and Mexico was about double import of goods from China.
The loss of deadweight of a tax is proportional to the amount of taxed item. The value of import is equal to the quantity times the price. But when running the DWL formula we can cancel the prize from China on the one hand and Mexico and Canada on the other.
So here is the bottom line. If Trump continues with the rate of 10% on China and the 25% rate on Canada and Mexico, the DWL from the rates in Canada and Mexico will be 65 times 2 times the DWL at rates on China. I get 6.25 by Squaring 2.5 (25% divided by 10%) and 2 of $ 900 billion divided by $ 440 billion. 6.25 * 2 and = 12.5. So the loss of Deadweight from Trump’s proposal rates in Canada and Mexico is about 12.5 times the DWL of the proposed 10% rate on China.
Comments: For simplicity, I assume that the basic line rate for these proposed rates is 0. That is not entirely true and the results would change a bit if I made it more accurate. The triangle in the photo is also the loss of deadweight of a load.