Candice Horbacz
In a recent op-ed for The Wall Street Journal, Stephen Miran, former chair of the White House Council of Economic Advisers, posited that the tariffs implemented during the Trump administration represent an improvement in tax policy. A central tenet of his argument suggests that the burden tariffs place on imported goods is effectively neutralized by full expensing provisions. Miran contended that tariffs do not genuinely increase the cost of imported business equipment and inputs because businesses can deduct these costs from their taxes under current full expensing rules, thereby rendering intermediate goods "largely untariffed." However, this assertion faces significant challenge from economic analysts who argue that tariffs inherently raise investment costs regardless of expensing measures.
The Policy Landscape: Simultaneous Tax Reform and Tariff Implementation
The debate over the interplay between tariffs and tax policy stems from a series of significant economic reforms and trade actions undertaken by the Trump administration. In 2025, a landmark legislative package, colloquially known as the "One Big Beautiful Bill Act" (OBBBA), was enacted. This comprehensive act introduced several critical provisions designed to stimulate domestic investment. Key among these were the establishment of permanent 100 percent bonus depreciation for short-lived assets, the reintroduction of expensing for research and development (R&D) expenses, and a temporary bonus depreciation specifically for manufacturing structures. These measures allowed businesses to fully and immediately deduct the cost of qualifying investments, effectively eliminating the income tax burden on new capital outlays. The overarching goal was to encourage capital formation, boost productivity, foster job creation, and ultimately enhance long-term economic growth by making investment more attractive.
Yet, simultaneously with these pro-investment tax reforms, the Trump administration also implemented a series of large, broad-based tariffs on a wide array of imported goods. These tariffs targeted not only finished consumer products but critically, also included intermediate goods—components and materials used in the production process—and capital goods, such as machinery and equipment. The stated objectives of these tariffs were multifaceted: to protect domestic industries from foreign competition, address perceived unfair trade practices by other nations, generate revenue, and leverage trade negotiations. This dual policy approach—reducing the tax burden on investment while simultaneously increasing the cost of imported investment inputs—created a complex economic environment that continues to be a subject of intense scrutiny and debate among economists.
Deconstructing the "Neutralization" Argument
Miran’s argument hinges on the premise that the ability of businesses to deduct the cost of imported goods, including the tariff component, effectively negates the tariff’s financial impact. He suggests that if a business can expense the full cost of an imported machine, including the 10% tariff paid on it, then the net cost to the business is not significantly higher than if there were no tariff. However, this interpretation, while intuitive at first glance, misrepresents the fundamental economic mechanics of tariffs and capital cost recovery.
Economists contend that tariffs fundamentally increase the acquisition cost of an asset. When a business imports a piece of machinery with a 10% tariff, it must pay 10% more upfront to acquire that asset. While full expensing allows the business to deduct this higher cost from its taxable income, it does not erase the initial outlay. The benefit of expensing is a reduction in the income tax liability associated with the return on investment, whereas a tariff is an upfront tax on the purchase itself. These are distinct mechanisms with different economic implications.
To illustrate this, economic analysis frequently employs the standard user cost of capital formulation. This metric quantifies the minimum pre-tax return an investment must generate to cover its costs, including taxes, depreciation, and the return demanded by shareholders. The formula for the user cost of capital, denoted as c, is typically expressed as:
c = [(r + δ) / (1 - u)] * [1 - uz + t(1 - φ)]
Here, r represents the real interest rate or the return demanded by shareholders, δ is the economic depreciation rate of the asset, u is the corporate income tax rate, z is the present value of depreciation deductions, t is the tariff rate, and φ (phi) is equal to u multiplied by z.
Breaking down this formula reveals how each factor contributes to the cost. The term (r + δ) / (1 - u) represents the pre-tax return required to cover capital costs and shareholder demands, grossed up by the corporate tax. The second bracketed term, [1 - uz + t(1 - φ)], modifies the acquisition cost based on tax deductions and tariffs. Specifically, (1 - uz) reflects the tax value of depreciation deductions, reducing the effective cost. Conversely, t(1 - φ) represents the tariffs paid on imported capital assets, t, reduced by a basis adjustment.
The crucial insight from this formulation is that tariffs, t, directly increase the acquisition cost of the asset. While depreciation deductions, z, and a lower corporate tax rate, u, reduce the overall cost of capital, the tariff component acts as an additive burden on the initial investment.
The Persistence of Tariff Burden
The argument that expensing neutralizes tariffs suggests that the tariff component is fully offset by the tax deduction. However, further algebraic rearrangement of the user cost of capital formula clarifies why this is not the case. The formula can be restructured to explicitly separate the tariff and business income tax effects:
c = (r + δ) * [(1 + t) / (1 - u)] * [1 - uz / (1 + t)]
A more common and revealing rearrangement that clearly shows the tariff as a multiplier on the entire cost of capital, independent of depreciation, is:
c = (r + δ) * (1 + t) * (1 - uz) / (1 - u)
In this equivalent formulation, the term (1 + t) acts as a direct multiplier on the entire cost of capital. This means that if a 10% tariff is imposed (t=0.10), the cost of capital is effectively increased by 10% across the board. Crucially, this (1 + t) factor remains present regardless of how generous the depreciation allowance, z, is.
Even in the most favorable scenario, where full expensing is granted (meaning z = 1), the corporate tax term (1 - uz) / (1 - u) simplifies to 1, effectively canceling out the corporate income tax burden. However, the tariff term (1 + t) stubbornly persists. In this scenario, the cost of capital simplifies to:
c = (r + δ) * (1 + t)
This algebraic demonstration unequivocally shows that even with full expensing, the cost of capital remains burdened by the tariff. The tariff directly inflates the initial price of the imported good, and while the subsequent expensing allows for a deduction of that higher price, it does not claw back the additional money paid at the point of import. The business still faces a higher upfront cost, which translates into a higher minimum required return on investment to justify the purchase.
Tariffs Can Outweigh Expensing Benefits: A Quantitative Analysis
Miran’s commentary also implies that imported investment is inherently better off under a regime of expensing plus tariffs than it was under prior tax law. However, quantitative analysis suggests this is often an overstatement of expensing benefits or an understatement of tariff burdens, or both. Tariffs can have a disproportionately larger impact on the cost of investment compared to the corporate income tax, particularly for assets that depreciate quickly. This is because tariffs apply to the entire value of the investment at the point of acquisition, whereas the corporate income tax applies only to the net returns generated by that investment over time. This distinction means that even relatively low statutory tariff rates can result in higher effective tax rates on investment than significantly higher corporate income tax rates.
Consider a hypothetical firm with a 5 percent discount rate that imports a machine. Prior to the OBBBA, this machine was depreciated in line with its economic decline in value, assumed to be 20 percent per year. Under the prior tax regime, the present value of depreciation deductions (z) for this asset amounted to 80 percent. With a statutory corporate income tax rate of 21 percent, the effective tax rate on this investment under prior law was also 21 percent.
With the introduction of OBBBA, the same machine now qualifies for full expensing, meaning z = 100%. In the absence of tariffs, the effective tax rate on this investment drops to zero, a significant incentive for capital formation.
Now, let’s introduce a 10 percent tariff on this imported machine, while retaining full expensing under OBBBA. Plugging these values into the user cost of capital formula yields a new user cost of capital (c) of 27.5 percent. When translated into an effective tax rate, this results in a staggering 33.3 percent. This outcome is highly instructive: despite the tariff rate being less than half the corporate tax rate, the effective tax rate on the investment rises to 33.3 percent. This figure is substantially higher than the 21 percent effective tax rate the investment faced prior to the introduction of full expensing and tariffs.
| Category | Prior Law | OBBBA (Without Tariff) | OBBBA (With Tariff) |
|---|---|---|---|
| Statutory Corporate Rate | 21% | 21% | 21% |
| Statutory Tariff Rate | 0% | 0% | 10% |
| Depreciation (z) | 80% | 100% | 100% |
| Effective Tax Rate | 21% | 0% | 33.3% |
This example, while simplified, powerfully illustrates the disproportionate impact of tariffs. The burden of tariffs is highly dependent on both the statutory tariff rate and the asset’s depreciation rate. Many imported assets eligible for bonus depreciation, such as computer equipment and industrial machinery, typically have high depreciation rates. Given that many of the Trump-era tariffs were at least 10 percent, the scenario presented is a realistic representation of the challenges faced by businesses.
Furthermore, the benefit of expensing might be slightly overstated in this simplified comparison. Prior to OBBBA, short-lived investments still qualified for significant bonus depreciation—40 percent in 2025 and 20 percent in 2026. Even if scheduled bonus depreciation had fully phased out, the Modified Accelerated Cost Recovery System (MACRS) used for tax purposes often provides slightly more accelerated depreciation than true economic depreciation. This implies that the ‘z’ value under prior law was likely higher than the 80 percent assumed in the example, meaning the pre-OBBBA effective tax rate might have been marginally lower, making the tariff’s impact even more pronounced by comparison.
Tariffs Impact Unexpensed Capital and Broaden Economic Strain
Miran’s argument also overlooks a crucial segment of the capital stock: assets that do not qualify for expensing but are nonetheless exposed to the effects of tariffs. A significant portion of the capital stock, particularly non-manufacturing structures such as residential property and commercial buildings, does not qualify for immediate expensing. While these structures are not typically imported directly, the intermediate goods and raw materials used in their construction frequently are. For instance, lumber, steel, and other building materials imported from abroad may be subject to import duties.
When tariffs are imposed on these intermediate inputs, the cost of construction for structures—which cannot be expensed—increases directly. This means that developers and construction companies face higher material costs, leading to increased overall project costs for residential and commercial buildings, without any offsetting benefit from full expensing. This indirect burden on unexpensed capital has significant implications for sectors like housing and commercial real estate, potentially leading to higher property prices, reduced construction activity, and slower growth in these vital economic segments.
The broader implications of tariffs, even in an environment of full expensing, extend beyond direct investment costs. They include:
- Reduced Competitiveness: U.S. manufacturers and businesses that rely on imported inputs become less competitive globally. If their input costs rise due to tariffs, their final product prices increase, making them less attractive in both domestic and international markets.
- Supply Chain Disruptions: Tariffs can force companies to reconfigure their supply chains, seeking alternative (often more expensive or less efficient) domestic or foreign suppliers. This can lead to production delays, increased logistical costs, and reduced operational efficiency.
- Inflationary Pressure: Higher costs for imported intermediate and capital goods are often passed on to consumers in the form of higher prices for finished goods and services. This contributes to inflationary pressures across the economy, eroding purchasing power.
- Slower Economic Growth and Job Creation: By increasing the cost of investment and production, tariffs can suppress overall economic activity. Reduced investment translates into slower growth in productivity, fewer new jobs, and stagnating wage growth, countering the intended benefits of expensing.
- Uncertainty for Businesses: The imposition and potential removal of tariffs create policy uncertainty, making it challenging for businesses to plan long-term investments and operations. This uncertainty alone can deter investment.
In conclusion, while full expensing is a powerful tool for reducing the income tax burden on new investment and stimulating economic growth, it does not, as Miran suggests, neutralize the burden imposed by tariffs. Tariffs are an upfront tax on acquisition that directly inflates the cost of capital, an effect that persists even when businesses can deduct those higher costs from their taxable income. The evidence, both algebraic and quantitative, clearly demonstrates that tariffs, even at modest rates, can impose a significant effective tax rate on investment, often outweighing the benefits of expensing and leaving the U.S. economy with a higher cost of capital.
For policymakers seeking to genuinely decrease the cost of capital and foster robust investment in the United States, the path forward is clear and significantly simpler: repeal the tariffs. Such a move would remove a direct, persistent, and often disproportionate burden on businesses, allowing the full benefits of investment-friendly tax policies like full expensing to materialize and contribute to sustained economic prosperity.
