The Tariff Mystery: Revenues Are Up, So Why Aren't Prices?

Tariff revenue is projected to surpass $300 billion annually, but where does that come from?

Companies have been announcing Q2 earnings over the past few weeks and so far, the results have been stellar. Approximately two-thirds of the companies that make up the S&P 500 have reported, and average year-over-year revenues and earnings have increased 6.0% and 10.3%, respectively. The average profit margin is 12.7%, compared to 12.2% last year, and a 5-year average profit margin of 11.8%. This means that firms have been not only growing revenues but also doing so more efficiently and profitably.

While earnings figures are coming in consistent to slightly better than previous quarters, they have been surprising many equity analysts; the common expectation was that the across-the-board tariffs imposed in Q2 would negatively impact the earnings of companies. Even more confusing to analysts is that the US Treasury is on pace to collect a record $300 billion in tariff revenue per year, and if that $300 billion isn’t coming out of earnings it must be coming from somewhere else. The most likely alternative source is companies are passing on the tariffs to consumers in the form of higher prices for goods. However, a quick look at the core PCE (personal consumption expenditures) price deflator shows that recently prices have been increasing at about 2.8% annually, which is no different than the last few months. Therefore, it does not appear that companies are passing on the tariff expenses to the consumer.

US Core PCE has averaged 2.76% over the last 12 months. In May and June of 2025 it was 2.8%

So, if companies are not paying for the tariffs through lower earnings, and consumers are not paying for it through higher goods prices, where are the tariff revenues coming from?

To answer this question, we can gain some insight by comparing earnings reports from US firms that earned the bulk of their revenues ex-US (in foreign markets) vs those that earned it in US markets (Apple is an example of the former while Amazon is an example of the latter). As stated before, the average earnings growth rate for all companies was 10.3%, but when we look at companies with US revenue and ex-US revenue the difference becomes clear. The earnings growth for companies with more than 50% of their revenues from foreign markets was a whopping 13.3%, and the earnings growth for companies with more than 50% of the revenues from the US was only 8.7%. This is despite the fact that both types of companies had total revenue growth of 6.0%.

The more revenue a firm has from the US, the greater the impact of tariffs.

Clearly, tariffs did have an impact on earnings. Firms with a majority of their revenues in the US were impacted substantially more by tariffs — their greater tariff expenses resulted in much slower earnings growth. And the opposite occurred for firms with a majority of their revenues outside of the US because their foreign revenues were not tariffed.

There are three things to take away from this result:

First, tariff revenues did impact corporate earnings. We can’t easily see the effect when looking at aggregate earnings, but it is obvious when comparing firms with mostly domestic revenues, or revenues exposed to tariffs, vs those with mostly foreign revenues.

Second, it appears those firms that had to pay tariffs did not pass them along to consumers (or passed on only a small portion). If they had we would have seen higher revenue growth for firms facing higher tariffs — the higher tariffs would have been passed on as higher prices to consumers, thereby resulting in higher revenues. However, there was no difference in revenue growth between firms with mostly domestic revenue vs those with mostly non-domestic revenue. Additionally, if prices had been passed on, we would have seen a substantial uptick in goods inflation. Instead, inflation barely budged, evidencing again that firms did not bump up prices and pass tariffs on.

Third, a follow up question arises, which is how did firms with mostly foreign revenues grow their earnings so much? Earnings at these firms grew so fast that they were able to fully offset the effects of tariff-driven earnings slowdowns at the firms with mostly domestic revenues — aggregate earnings growth was right in line with past quarters.

The decrease in the value of the USD directly affected the earnings of firms with ex-US earnings.

The answer to our question lies in the currency markets. Essentially, the US Dollar (USD) weakened considerably during Q2. The USD depreciated 7.1% (i.e., foreign currencies strengthened) against a basket of foreign currencies (DXY). As a result, all foreign earnings converted to higher USD earnings on companies’ earnings reports; the firms with mostly foreign revenues not only avoided the costly US tariffs and therefore had lower expenses but they also reported higher revenues due to the weaker USD. It’s the combination of these two effects that explains the substantially higher earnings growth of firms with mostly foreign revenue.

An important implication of these findings is the potential for a sustained rise in inflation. As explained in the second point above, most of the tariff expenses have yet to be passed on to consumers. That is why firms with mostly domestic revenues had much lower earnings growth. However, looking at historical patterns, we know that tariff expenses will most likely eventually be passed on — it will likely happen slowly over many quarters, with a larger percentage of the tariffs being passed on each quarter until they are entirely passed on.

What this means for goods prices over the next few months and quarters is that we should see a slow acceleration of prices as firms build in tariff expenses into product prices. This will result in higher inflation and would not be a one-time adjustment in prices that many economists, especially those in the White House, were predicting. A one-time adjustment would imply a single, big jump in inflation, but price adjustments over many quarters will mean a slow and prolonged increase in inflation. When combined with the substantial fiscal stimulus coming from the recently passed tax bill, wage pressures due to net zero immigration, and higher costs being added as firms tariff-optimize their supply chains, we may be looking at inflation likely in the range of 3.5% to 4.0% (far from the Federal Reserve’s 2.0% target) for however long it takes firms to pass through price increases. Once the tariffs are fully passed on to consumers, inflation should cool slightly to 3.0% to 3.5%, but nevertheless will still be nowhere near the Fed’s target rate of 2.0%.

The question for the Fed is whether they will continue to try to get inflation down to 2% or accept a higher inflation rate of about 3.0% to 3.5%. If they try to get it down to 2% it would require a substantial contraction of the economy to offset the above-mentioned forces pushing prices higher but this would violate half of the Fed’s mandate, maximum employment (the other half of the mandate is price stability at the current target 2% inflation rate). It is not clear that it will happen, but the hope is that Fed settles for this new, higher inflation target and focuses far more on keeping inflation volatility ultra-low (price stability) rather than inflation itself ultra-low. Because it is the uncertainty of future inflation that makes corporate investment decisions risky and difficult — predictable inflation is very manageable.