Optimal Tariff vs Retaliatory Tariff

The optimal tariff maximizes a country's welfare on the assumption that trading partners do not adjust their own policies. It exploits terms-of-trade market power: by restricting imports, a large country drives down the world price of what it buys. The Liberation Day tariffs paper estimates this rate at roughly 19 percent uniform for the United States.

The retaliatory tariff is the outcome when every government plays the same game simultaneously. Each country sets its tariff to maximize own welfare given what others are doing, and the resulting Nash equilibrium involves higher tariffs, lower trade volumes, and welfare losses for nearly all participants. The global tariff war paper quantifies this equilibrium and finds that the costs have doubled over 15 years as supply chains have deepened.

The gap between these two objects is not a technicality. A 19 percent unilateral tariff produces a small welfare gain; the Nash equilibrium that follows from universal adoption of this logic produces losses on the order of several percent of real income. The revenue paper adds a fiscal dimension: roughly half of trade-tax revenue vanishes once retaliation contracts the tax base.

Policy debates that cite optimal-tariff calculations without accounting for retaliation are comparing a best-case unilateral scenario against a status quo, when the relevant comparison is a strategic equilibrium against the status quo. The distinction matters most for large economies whose tariff choices provoke the strongest responses.