U.S. Liberation Day Binds The World To High Tariffs

Date Published: April 2, 2025

U.S. Liberation Day Binds The World To High Tariffs

The U.S. administration announced broad reciprocal tariffs today, targeting all trading partners, and not just the countries that run large trade surpluses with the U.S. The tariffs will be implemented under the International Emergency Economic Powers Act (IEEPA) of 1977.
Using IIEPA authority, the U.S. will impose a 10% tariff on all countries, effective April 5th, 2025. However, the administration also imposed higher tariff rates on countries with the largest trade deficits, which takes effect April 9th.
Based on today's announcement, we estimate that the U.S. effective tariff rate will jump to over 20%, the highest level since the 1940's and a larger increase than what occurred under the Smoot-Hawley legislation during the early 1930s.
Canada is exempt from reciprocal tariffs and the baseline 10% rate, as prior tariff announcements remain in effect. This leaves the effective tariff on Canada at around 10%, close to what we assumed in our March quarterly forecast. This rate is likely to come down as more companies adjust to qualify their goods as USMCA compliant. Given the scarring on consumers and businesses, our forecast for a pullback in economic growth alongside higher inflation remains intact.
Relative to our baseline assumptions, the tariff rates for non-USMCA countries are a step higher. For the E.U. the 20% rate announced today is in line with what we had assumed. However, this is not true for all others. China will be more heavily hit than our baseline assumption of 30%. Likewise, on other trading partners, we had assumed a blanket 5% rate which is now a minimum of 10%, with many countries higher like Taiwan, South Korea and Vietnam at 32%, 25% and 46%, respectively.

U.S. Implications

Today's announcement will raise the U.S. effective tariff rate to over 20%, the highest level since the early-1940's and notably above the 14% assumed in our Quarterly Economic Forecast. At this point, the big unknown is duration. Our forecast assumes that the peak tariff rate remains in-effect for just six-months, after which most countries/regions (except for China) see some reprieve. Should the tariffs remain elevated for longer, the odds of U.S. economic stagnation rises. Likewise, inflation is at risk of approaching 4% or more.
Heightened trade uncertainty has already led consumers to tap the brakes, with households increasingly worried about inflation, employment, and income prospects. Consumer spending is tracking a paltry 0.5% in the first quarter, after expanding by a robust 3.6% annualized in H2-2024.
The constant saber-rattling of tariff threats has also distorted trade flows, with imports surging in recent months as businesses try to front-run the tariffs. Net trade could shave several percentage points from Q1 GDP growth. Given the weak spending backdrop, the economy is at risk of contracting.
Tariffs that remain in place indefinitely would force some reshoring of production, but this would be a multi-year process and would come at a cost. Assuming a permanent tariff rate close to today's proposed level, our model suggests that it could lift the level of employment by nearly 500,000 in the long-run, most of those jobs related to manufacturing. However, the tariffs would also raise the average household's cost of living by over $4,850 per year – equivalent to a tax hike of 2% of GDP – implying an associated cost of $1,250,000 for every job reshored.
- Reshoring jobs is just the first hurdle. The manufacturing sector faces significant headwinds with persistent skill and labor shortages. Job openings within the sector already sit at more than 450,000 positions. Adding another 500,000 positions over the coming years will be a challenge without significant investments in skills training and recruitment, particularly for software and technical skills. The manufacturing jobs of yesterday are not those of the future.
The tariffs are likely to be viewed as helping to pay for proposed tax cuts. These include exempting Social Security payments, tip income and overtime pay from taxation. Combined, these policy changes are estimated to cost north of $3.5 trillion over the next decade, in addition to the $4 trillion required to extend the 2017 Tax Cuts & Jobs Act (TCJA). If today's tariffs become permanent, they could generate an estimated $6 trillion in revenue over the next decade, more than offsetting the cost to extend TCJA. Extending TCJA avoids fiscal tightening, but does not provide an additional boost to momentum. The economic multiplier is zero (see Perspective).

Canada Implications

For now there are no changes for Canada relative to prior announcements. Canada is exempt from the reciprocal tariffs and the baseline 10% rate.
Instead, Canada will continue to be subject to the 25% “fentanyl/illegal immigration” tariff, with 10% on energy and carve outs for USMCA compliant goods. It’s estimated that around 40% of the dollar value of goods travelling across the border are declared as USMCA compliant, although more firms may make the effort to become compliant. It’s estimated that 80-90% of the value of exports could become USMCA compliant. If the U.S. decides that progress has been made on fentanyl/illegal immigration, the 25% non-compliant tariff will be cut to 12% (and energy/potash would be exempt all together).
Past tariff announcements have already begun snaking through supply chains, such as 25% on steel and aluminum. Then there’s the 25% tariff on finished vehicle imports that take effect tomorrow. As it stands, the effective tariff on Canada is now around 10%, up from less than 2% before President Trump came into office. This is close to the 12.5% we assumed in our baseline forecast last month. Bear in mind that USMCA -compliant auto parts and lumber are still caught in the crosshairs without a specific timeline.
Canada previously retaliated with approximately $60 billion in tariffs on U.S. goods, with the next tranche set at $125 billion based on the Liberal government's guidance in February. With elections on April 28th, how the incoming government will respond remains to be seen.
Our baseline assumed all levels of Canadian government would spend an extra 1% of GDP in 2025 to support growth. That now appears to be on the low end. Based on the provincial budgets released to date, stimulus measures have already totaled 0.3% of GDP. Ontario is expected to release its budget sometime in mid-April, potentially bringing the cumulative fiscal spend to 1% of GDP. Adding Federal fiscal measures could double this figure. Although this will take the sting out of tariffs, it won’t prevent near-term economic stagnation as companies and labour markets absorb the policy shock. Canada will need to brace for a long period of economic restructuring. Even if the tariffs are removed or lessened in short order, Canadians cannot “unsee” the past three months. Returning to a place of commitment and trust would be unrealistic.
Inflation is expected to reach above 3% by the summer, with any easing achieved through lower tariff rates. For the Bank of Canada, they will be closely monitoring two areas: inflation expectations and governments' response. As the central bank has noted, they have limited capacity to push against a policy shock of this nature. Don’t expect a substantial drop in interest rates, but there is room for at least 50 basis points of cuts to ease financing costs.

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