Trump May Be Raising Your Taxes With His Tariffs, but He Could Actually Cut Inflation With Them Too, SF Fed Says

The sharp increase in tariffs imposed last year by the Trump administration may reduce inflation rather than increase it, according to research published Monday by the San Francisco Federal Reserve Bank, suggesting that interest-rate cuts may be the proper policy response.

U.S. imports were subject to an average 17% levy last year, up from less than 3% at the end of 2024 and the highest rate since 1935, according to Yale Budget Lab.

Our analysis of historical data highlights a possibility that the large tariff increase of 2025 could put upward pressure on unemployment while putting downward pressure on inflation, researchers Regis Barnichon and Aayush Singh said in the regional Fed bank's latest Economic Letter, which builds on their working paper published in November.

Why Did This Happen?

The 15% increase in the average U.S. tariff rate in 2025 was the largest in the modern era. Assessing the likely impacts of such a large and sudden change, or tariff shock, on unemployment and inflation is crucial for monetary policy discussions.

The San Francisco Fed researchers examined 150 years of empirical data on the United States as well as France and the UK according to their analysis.

How Did Markets React?

The Fed held rates steady for much of last year on concern that tariffs would add to inflation, as theoretical models as well as some empirical data suggested.

By September, signs of labor market weakness and a growing conviction that any inflationary boost from tariffs would be short-lived prompted the Fed to begin a string of rate cuts that lowered short-term borrowing costs by a total of 75 basis points in 2025.

What Are Analysts Watching Next?

Economic uncertainty and a drop in stock prices, both of which typically coincide with large tariff shocks, may explain why higher import levies reduced inflation in the past.

They did not examine how that historical experience may have mapped to last year, when uncertainty by many measures rose sharply but major U.S. stock indexes also posted double-digit gains, fueling U.S. household spending and buoying the economy.

The historical findings may not apply perfectly to today's economy, the San Francisco Fed researchers wrote, noting that U.S. manufacturing today relies more on imported products than it did in the past, meaning that tariffs may now be more likely to trigger higher inflation.

Jan. 6 data shows U.S. inflation pressure is far lower than market expectations. The latest CPI from the U.S. Bureau of Labor Statistics hit 2.7%—well below Wall Street's prior consensus forecast of 3.1%— catching markets off guard.

Since Trump announced 'Liberation Day' tariffs in April last year, markets have widely expected tariffs to push up inflation. But two recent studies from the San Francisco Fed note that historical experience shows tariffs haven't triggered a large-scale inflation surge.

That's because importers have shifted supply chains, avoided tariffs, negotiated exemptions with countries, and significantly diluted effective tax rates. The studies conclude tariffs' negative impact on economic growth and jobs is more pronounced, while their inflationary effect is far smaller than expected.

A Pantheon Macroeconomics report highlights U.S. tariff revenue has started to decline: • October peak: $34.2 billion • November: $32.9 billion • December: $30.2 billion according to their analysis.

Analysts note the current average U.S. effective tariff rate is around 12%. Institutions estimate tariffs have a 0.9 percentage point impact on Personal Consumption Expenditures (PCE) inflation, with 0.4 percentage points already absorbed by markets. The main inflation shock may have passed, and core PCE is expected to near the 2% target this year.

Lower-than-expected tariff revenue has eroded the U.S. government's fiscal space. Treasury Secretary Bessemer previously projected tariffs would generate $500 billion to nearly $1 trillion in revenue, but independent calculations show 2025 tariff revenue may only reach $261 billion to $288 billion.

The U.S. has a cumulative $439 billion deficit for fiscal 2026, with total national debt exceeding $38.5 trillion. With falling tariff revenue, the sustainability of Trump's proposed 'Trump Account' and universal cash subsidy plan is in question.