The War Tax: How the Iran Conflict Became America's Most Regressive Economic Policy

On the morning of June 3, the Federal Reserve released its June Beige Book — the central bank's plainspoken, district-by-district account of what is actually happening in the U.S. economy at street level, assembled through thousands of conversations with business owners, executives, farmers, and local economists across all twelve Federal Reserve regions. The Beige Book is not a policy document. It does not move markets in the way that an interest rate decision does. What it does is strip away the abstraction of macroeconomic modeling and report what people are experiencing on the ground.
The June edition's verdict was blunt: "Energy-related costs tied to the conflict in the Middle East were the primary driver of inflationary pressures, with spillovers into shipping, packaging, groceries, and fertilizer. Consumer uncertainty and concerns about fuel prices impacting households were noted by several Districts."
That sentence, buried in the summary section of a government report, is as complete a description of the current American economic moment as any analyst's note or think-tank forecast. A war that began on February 28 with U.S. and Israeli strikes on Iran has, in roughly one hundred days, fundamentally reshaped the inflation picture for the world's largest consumer economy. The mechanism is not complicated. The consequences, however, are anything but simple — and they are landing with very different force on very different Americans.

What Is Still Happening in Kuwait — and Why It Matters Economically
Before getting into the economics, the military situation needs to be understood, because it is not over. Not even close.
The ceasefire between the United States and Iran, brokered in April, is technically still in effect. It is also, in the plain assessment of every analyst watching it, holding by a thread. On June 3, Kuwait's government confirmed that an Iranian missile and drone attack had struck its international airport, killing one person and wounding dozens more. Debris lay across the terminal floor. Fires burned. Kuwait's foreign ministry stated that the country reserved "its full and inherent right to take appropriate measures in response to these sinful and repeated Iranian attacks."
The IRGC, in its characteristic style, claimed the attack as retaliation for earlier American strikes. Iran's foreign ministry then denied that the airport strike had happened, blaming damage on an errant U.S. Patriot missile. Washington described its own strikes as "self-defense strikes" on Iranian military positions. The truth, as is typical in this conflict, sits somewhere in the gap between the competing statements — but the practical consequence is clear: the ceasefire exists on paper and is regularly violated in practice.
The military history of the past hundred days is worth recounting briefly because it provides essential context for the economic damage that followed. From February 28 onwards, Iran launched Operation True Promise IV — a campaign of retaliatory strikes targeting regional states hosting U.S. military assets. Kuwait bore the brunt of it. According to compiled data, Iran fired 97 ballistic missiles and 283 drones at Kuwaiti targets; 7 U.S. soldiers were killed and dozens wounded; Kuwait International Airport was struck repeatedly, leading to a full suspension of commercial aviation in Kuwaiti airspace. On May 1, six IRGC troops were apprehended on Bubiyan Island inside Kuwaiti territory — a land incursion during a nominal ceasefire. The IRGC has consolidated its internal power position within the Iranian government since the war began, a development that makes negotiated de-escalation structurally harder, since the IRGC's institutional interest is in continued confrontation, not resolution.
The ceasefire's fragility is not an abstraction. Every exchange of fire, every missile intercepted over Kuwait City, every American "self-defense strike" on Iranian positions, keeps the risk premium embedded in energy prices alive. Markets price geopolitical risk in real time. As long as Kuwait International Airport is being hit by Iranian drones, traders in London and Singapore are not going to bet that the Gulf energy supply chain is stable. That risk premium is the invisible bridge between the war in the Persian Gulf and the grocery bill in Ohio.

The Transmission Mechanism: From Hormuz to Your Grocery Cart

Understanding how a war in the Persian Gulf raises the price of lettuce in a supermarket requires tracing a chain of causation that spans continents and commodity categories. The Fed's Beige Book identified four specific spillover channels: shipping, packaging, groceries, and fertilizer. Each one is worth unpacking, because they compound each other.
Energy and fuel is the first and most direct link. Iran's effective closure of the Strait of Hormuz beginning February 28 removed roughly 20% of the world's daily oil supply from accessible markets virtually overnight. Brent crude surged from around $64 per barrel in February to a peak of $138 in April. At $4 a gallon nationally, U.S. average gasoline prices crossed a threshold last seen in 2022. Diesel — the fuel that powers the trucks that deliver everything Americans buy — moved in lockstep. Cleveland Fed contacts specifically flagged increased fuel surcharges being applied across supply chains.
Shipping costs are the second channel. The Strait closure forced container shipping onto the Cape of Good Hope route, adding 10 to 14 days and thousands of miles to Asia-Europe and Asia-U.S. voyage times. Longer voyages mean more fuel burned, more vessel-days consumed, and less total fleet capacity available for a given volume of cargo. Freight rates rose. Those higher freight costs enter the cost structure of every company that imports physical goods — which is to say, almost every company that sells physical goods.
Packaging is less intuitive but equally real. Plastic packaging is derived from petrochemicals. Cardboard and paper packaging relies on energy-intensive production processes. Fertilizers — particularly nitrogen-based fertilizers — are manufactured using natural gas as a feedstock. When natural gas prices rise because LNG from Qatar's Ras Laffan facility cannot transit the Gulf normally, the cost of producing fertilizer rises. When fertilizer costs rise, the cost of growing food rises. When food production costs rise, grocery prices follow — with a lag measured in months, not years.
The Cleveland Fed did not need to explain all of this in its Beige Book submission. It simply noted the fuel surcharges and the margin compression. But the chain of causation is there, embedded in every line of the Beige Book's national summary.

The Beige Book's K-Shaped Portrait

One of the most revealing details in the June Beige Book was not about prices at all. It was about the divergence in how different income groups are experiencing the same inflation shock.
The report noted that input costs are "rising faster than selling prices" — meaning businesses are absorbing some of the cost increase rather than passing it through entirely. This margin compression is not evenly distributed. Large companies with pricing power — national retailers, airline operators, Amazon — have been able to raise prices to partially offset their cost increases. Smaller businesses, particularly consumer-facing ones in competitive local markets, face a harder choice: raise prices and lose customers, or hold prices and destroy margins. "The ability to pass on higher costs remained mixed across sectors," the Beige Book said, "particularly among consumer-facing firms."
The Beige Book also noted that firms across multiple districts were deploying what it called "inflation mitigation strategies" — supply-chain optimization, product adjustments, reduced product offerings, temporarily absorbing higher costs. In plain language: some companies are offering smaller pack sizes for the same price, removing lower-margin items from their range, and quietly eating losses to hold customer relationships. These are not strategies that can persist indefinitely.
Meanwhile, consumer behavior is splitting along income lines in ways that UBS, Moody's Analytics, and Oxford Economics have all documented this year. Dollar General reported on June 2 that it was seeing an influx of higher-income shoppers — people who normally shop at mid-tier grocery chains but are now looking for cheaper alternatives as their food budgets come under pressure. That is a telling data point. When middle-income households migrate down the retail ladder toward discount stores, it signals that the energy shock has moved well beyond the lower-income consumers who are always first hit by fuel price spikes.
Moody's Analytics called this dynamic explicitly: the war is "effectively a tax on U.S. households" that is accelerating the economy's K-shape. The K metaphor describes an economy where the top half — households with higher incomes, significant financial assets, and spending patterns not dominated by fuel and food — continues to do well, while the bottom half faces a growing squeeze. Energy price shocks are structurally regressive. Gasoline is not optional for most American workers. A household earning $50,000 a year in a suburb with no public transit does not have the choice to simply drive less when gas hits $4 a gallon. A household earning $200,000 a year does, at least in marginal ways. The war in Iran is not inflicting the same economic damage on everyone. It is inflicting sharply different damage depending on where you sit in the income distribution.
UBS analysts put it plainly in a March research note: "The rise in oil prices should add a meaningful burden to household budgets and intensify strains already visible across the consumer landscape." They noted that lower-income retailers like Ollie's Bargain Outlet and Dollar General were likely to see sales decrease as consumers face budget constraints, while premium retailers with affluent customer bases would be relatively insulated. Oxford Economics, in a parallel analysis, forecast that 2026 would deliver the slowest annual consumption growth since 2013, excluding the pandemic — a consequence of higher energy prices "more than offsetting" the boost to spending that was expected to come from larger tax refunds in the spring.

What Businesses Are Actually Doing

The Beige Book captures something important about how the business community is responding to this shock, and it is not the straightforward price-hike story that inflationary periods often produce.
Across multiple districts, contacts described a world of constrained options. They cannot easily raise prices — consumer price sensitivity is high, and the customer base is already under pressure. They cannot easily absorb the cost increases either, because non-labor input costs are rising faster than selling prices in most categories. So they are adapting: optimizing supply chains to reduce fuel exposure, switching suppliers where possible, reducing product variety to concentrate volume on higher-margin items, and absorbing losses on lower-margin product lines temporarily.
Paul Dietrich, chief investment strategist at Wedbush Securities, described the business reality for smaller operators: "Now there's the U.S.-Iran war and a surge in diesel fuel prices that is eating into profit margins. Yet, he doesn't feel like he can raise prices." That "he" is a composite of thousands of small business owners across the country who are caught between cost structures they cannot control and customer relationships they cannot afford to damage.
Delta Air Lines CEO Ed Bastian offered the other side of the equation. With strong demand in premium travel, Delta indicated it had the market position to raise airfares as a response to higher fuel costs if needed. Large airlines with brand power and high-yield customer bases can pass through fuel cost increases in a way that a rural propane dealer or a regional trucking company simply cannot. The gap between businesses that have pricing power and businesses that do not is one of the defining economic divides of this moment.
For grocery retailers specifically, the dynamics are particularly sharp. Food shoppers at the lower end of the market are trading down. Retailers that serve those customers are seeing margin pressure from both directions: higher input costs and more price-sensitive customers. Retailers at the premium end — Costco, Whole Foods, luxury food brands — are largely insulated because their customer base has the financial cushion to keep buying.

The IRGC Factor: Why This Shock Has No Clear End Date

One dimension of the current inflation situation that is genuinely different from previous oil price shocks is the institutional character of the adversary holding the Strait.
Previous Gulf crises — the 1973 OPEC embargo, the 1991 Gulf War, even the 2019 attacks on Saudi Aramco facilities — were relatively bounded events. States with economic interests in returning to normal eventually did so. Supply disruptions had identifiable end dates or at least plausible resolution pathways.
The IRGC's consolidation of power inside Iran changes this calculus in important ways. The Islamic Revolutionary Guard Corps is not a conventional military or a government ministry that responds to economic incentives in the standard diplomatic sense. It is an ideological organization with deep institutional interests in the continuation of the conflict and in maintaining Iran's leverage over the Strait of Hormuz. Iran's new supreme leader, Mojtaba Khamenei, declared in his first public statement after taking power that the Strait's closure should be maintained as "a tool to pressure the enemy." That is not the statement of an institution looking for an off-ramp.
The IRGC's institutional entrenchment means that even a signed peace deal between the U.S. government and the Iranian government — the MOU that President Trump has yet to sign as of this week — does not necessarily mean the Strait reopens fully and the energy shock ends. The ceasefire is already being violated while it nominally exists. An extended ceasefire would be, by the available evidence, a version of the same pattern with slightly longer intervals between violations.
This is what Lydia Boussour, senior economist at EY-Parthenon, meant when she said "full normalization will still take time, especially when it comes to supply chains, when it comes to energy capacity." She was not being cautious for the sake of it. She was describing a situation in which the institutional actors controlling the Strait do not have the same incentives toward normalization that markets are pricing.
The OECD's assessment was characteristically measured but pointed in the same direction: "The breadth and duration of the conflict are very uncertain, but a prolonged period of higher energy prices will add markedly to business costs and raise consumer price inflation, with adverse consequences for growth." It projected U.S. inflation hitting 4.2% if the war drags on — the highest among G7 countries — and GDP growth slowing to 2% in 2026 and 1.7% in 2027.

The Fed's Impossible Position

All of this lands on a Federal Reserve that is operating, as of June 17, under a new chair with his own political pressures, an inflation mandate that has been in breach for more than five years, and a monetary toolkit that is poorly designed for the problem at hand.
The June Beige Book's description of the economic situation is one that no interest rate decision can easily solve. Energy-driven inflation is not, in the standard macroeconomic framework, best addressed by raising interest rates. Higher rates slow demand, reduce investment, and cool wage growth — but they do not increase the supply of oil flowing through the Strait of Hormuz. Jerome Powell acknowledged this directly earlier in the year when he indicated that short-term oil shocks are normally a factor that central banks look through when analyzing underlying inflation and longer-term expectations.
The problem is that this oil shock is not short-term. It began in February. It is still going in June. The second-round effects — the pass-through from energy costs into food, shipping, packaging, and fertilizer that the Beige Book documented — are accumulating month by month. At some point, a persistent energy-driven inflation that feeds into core prices through supply-chain channels stops being something a central bank can credibly "look through" and becomes something it has to respond to.
That inflection point may be approaching. The PCE inflation measure is projected to approach 4% by year-end. Core inflation, which strips out food and energy, has been creeping up rather than down. J.P. Morgan's macro team now projects the Fed holds rates through all of 2026 before hiking in Q3 2027. Several economists have given meaningful probability to a hike this year. The Beige Book's own language — prices increasing "at a moderate to strong pace" in most districts, with "most Districts reporting higher inflation from the previous report" — is not the language of an inflation problem that is resolving itself.
Kevin Warsh's first FOMC meeting, on June 17, will produce a hold. That much is certain. What is not certain is whether the Beige Book's portrait of an energy shock rippling through every supply chain in America is the beginning of a temporary disruption or the first chapter of something that requires a fundamentally different policy response.
The answer to that question depends, more than anything else, on what happens in Kuwait over the next six weeks.