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Wealth & Poverty Review Rationalizing Tariffs

Originally published at New World Economics

Economic Nationalism tends to boil down into two basic policies: tariffs, and limited immigration. Sometimes, in the past, it has meant currency devaluations, but today that is not really proposed. On a broader basis, it means that economic policy should result in positive outcomes, for the whole of the population. This might mean suppressing some elements of “free enterprise,” for example, limiting child labor, or banning consumer lending at rates above 10% — which used to be a common law among States, until around 1980.

Controlling immigration is a much more important topic, these days and probably throughout US history, than tariffs. But, let’s look now at tariffs.

In the past, the US Federal Government was funded by two basic indirect taxes: excise taxes, and tariffs. This followed a long tradition of “indirect” taxation, as a principle of liberty and good government, going back to the days of Ancient Greece. “Excise taxes” are basically taxes on individual items. A dollar tax on a gallon of gasoline, for example. For over a thousand years previous, governments had experimented with “turnover taxes,” a tax on the sale of anything. But, this would tax an item, or the raw materials of the item, several times as it moved to market. Also, it was a tax on asset transactions such as equities or land. In practice, it could easily become highly destructive, and played a part in both the demise of the Arab Empire (the Saracens), and also Imperial Spain. (A major rise in a “turnover tax” in Germany in 1932 was probably a big reason for the horrible collapse of the German economy that year, among the worst in the developed world, while neighboring France, which didn’t raise taxes, was almost untouched. That was pretty much the end of “turnover taxes” in the developed world.)

Taxing individual items was a way of avoiding this outcome. However, you soon ended up with hundreds and often thousands of taxes on individual items, and even then it didn’t raise much revenue. It was enough revenue for peacetime, but fell short in wartime. Obviously, with hundreds of somewhat arbitrary taxes on individual items, each tax became an item of contention. If there was a $0.10 tax on pencils, there would be a political struggle to either raise it to $0.11 (paid for by pen manufacturers), or to lower it to $0.09 (paid for by pencil manufacturers). These taxes tended to be quite high, for example an effective 50%-100% of the product price, because even though there were hundreds of excises, this still only covered a small portion of all goods and services for sale. Such a high tax rate naturally provoked resistance and also avoidance. A tax on newspapers led to the “broadsheet” large newspaper format that is still in use today. A high tax rate also led directly to political contention over every rate.

These issues were resolved in two ways. First, the modern introduction of the Income Tax in Britain in 1799 provided a new source of wartime revenue. In the United States, the introduction of the Income Tax in 1913 relieved the Federal Government of its reliance on revenue from excise taxes, especially on alcohol which provided I think about 30% of total tax revenue at the time. This paved the way for the Prohibition and the 19th Amendment, and also provided a handy way of financing World War I which conveniently popped up a year later. The first British income tax was abolished in 1816, but reappeared in 1842 at a low rate of 3%. This allowed the British government to reduce its reliance on excises and tariffs, including the Corn Laws which were implicated in the Irish Famine of 1845-1852. The Corn Laws, and hundreds of other tariffs and excises, were eliminated beginning in 1846, which marked Britain’s move toward Free Trade.

The system of Excises was resolved in the 1930s in the form of the Retail Sales Tax, which only taxed final retail products, not wholesale. Also, it excluded asset transactions. Now, you could have one simple tax rate, which applied across the board. There wouldn’t be contention over every single tax among hundreds of taxes. There would just be a low rate, under 10%, which was not that big a deal and easy to administer. You could just argue over that one rate. There wouldn’t be battles between pencil manufacturers and pen manufacturers. Nobody would print newspapers on stupidly oversized paper to avoid a 10% tax.

Later, the Value Added Tax, introduced in the 1950s, served as a still more refined version of the Retail Sales Tax. Today, the Retail Sales Tax and the Value Added Tax raise a ton of revenue, with a single low rate, easy administration, and not much political contention. This also relieves the need for the Income Tax, which was originally introduced because RSTs and VATs did not yet exist.

June 16, 2020: The Evolution of Tax Technology

Now we come to tariffs.

Tariffs are not much different than nineteenth-century excises. They are usually individual taxes on individual items. They have all the problems of the excise system, including ridiculous overcomplication, with hundreds of individual tariffs. Actually, it is even worse than that. Every tariff also becomes a foreign policy issue. Plus, not only do you have tariffs on individual items, you have tariffs on individual countries, with steel from China being taxed while steel from Germany is not. Then, you have competitiveness issues. An excise on pencils applies to all pencil producers, foreign and domestic. You still have issues with the pen producers, but at least it treats all the pencil producers “uniformly.” But, a tariff will advantage domestic producers over foreign producers, which is an advantage worth fighting for. This drives the already-high levels of political contention still higher. US history before about 1950 is replete with major contention over tariffs, which played a role in the Civil War and Great Depression, among other less prominent events.

Internationally, the high tariffs of the late 19th century (typically around 100%) was a direct impetus for European Empire, and the push to include the entire supply chain, and consumer demand, within a single political entity that enjoyed free trade within its borders. European colonization was driven by the desire for “raw materials and markets for finished goods,” in other words, all the things made difficult by 100%+ tariffs between European governments. This rush toward Empire provoked contention between the European powers, notably Britain and Germany, which was a major factor in World War I, and also World War II when Japan attempted to construct a free-trade zone in Asia (“economic co-prosperity sphere”) after the US and other European governments attempted to cut off trade to Japan, including all fossil fuels.

Whoops.

With the rise of the Income Tax after 1913, the Federal government no longer needed to rely upon tariffs for revenue. This left tariffs as mostly a matter of “protectionism.” This resulted in a disaster during the Great Depression, with the Smoot-Hawley Tariff setting off a chain of policy error worldwide. So, by the late 1940s and early 1950s, the United States too turned toward Free Trade as a principle, reducing all the issues surrounding tariffs.

I think this policy toward Free Trade has resulted in some major problems in recent decades, particularly after about 1980 with the introduction of Chinese (and other Asian) labor into the world market, plus NAFTA and other issues that have been well discussed. Nevertheless, any pro-Tariff talk immediately receives resistance from the Free Traders, drawing on 200 years of big tariff problems before the post-WWII Free Trade era.

The solution that presents itself is the adoption of a flat-rate tariff, similar to the Retail Sales Tax. The VAT actually already includes this element, with all imports subject to the VAT rate. This rate would apply to all items, from all sources. It would probably be around a 10% rate. There would not be separate rates for different countries.

This is not a new idea. It was proposed to the economic nationalists such as Patrick Buchanan in the 1990s, and was indeed adopted by Buchanan and others. It would probably raise a lot of revenue, which would allow other taxes to be lowered. In Suicide of a Superpower (2011), and other writings, Buchanan proposed a 10% across-the-board Tariff, revenue from which would allow the elimination of the Corporate Income Tax. This would make US business about the most competitive in the world, which would mean high demand for US workers, and rising wages especially for the lowest income brackets.

I don’t like that idea too much, since I think that corporate income, or business income (including self-employed and non-incorporated business) — the primary income of the wealthy — should be taxed at the same rate as employment income. Warren Buffet doesn’t pay much Individual Income Tax, but, indirectly, he pays a ton of Corporate Income Tax. In 2019, Berkshire Hathaway paid $3.6 billion in corporate income tax. Buffett owns 16.45% of Berkshire, so he indirectly paid about $592 million of taxes. This is easier to see in the case of a 100%-owned business, where an individual has full control of all the profits. How can we argue that this person didn’t earn the profits of the business that he has total ownership of, even though it was not distributed in the form of dividends? How can we argue that the taxes paid by the 100%-owned business were not, effectively, paid for by the 100% owner? We can’t.

More like a 15% across-the-board Flat Tax or VAT for both business and employment income would be good. By “Flat Tax” here I mean a single tax, like a payroll tax, from the first dollar to the last, rather than the existing payroll tax (about 15%) layered with a separate Flat Tax (about 15%), the common proposal of the 1990s. Among these options, I would go with a 10% VAT and also shrink the spending side, by devolving all domestic programs (health, education and welfare) to the States, which are already administering these programs. So, it would look like a 10% VAT, a 10% Tariff, and no payroll or income taxes. This is not much different than the Federal Government in 1910, although with a uniform VAT and Tariff instead of hundreds of individual excises and tariffs. It would be an extension of the 18th century principle of Uniformity in taxation, with 20th century and 21st century updates.

May 28, 2019: “Uniformity” In Taxation Was Our Blueprint For Greatness

April 28, 2021: Grand Unified Theory of Indirect Taxes

The point here is: I think that Economic Nationalism, and practically speaking, tariffs, deserve serious consideration. But, that discussion can’t even begin if you have the horrible nineteenth-century system of individual tariffs, further complicated by individual tariffs for individual countries — the exact policies that the Trump Administration favored not too long ago. The better Economic Nationalists already understand this, but it needs to be a more prominent part of the discussion.

Nathan Lewis

Fellow, Center on Wealth & Poverty
Nathan Lewis is the author of four books on economic topics, including three about the gold standard. He has maintained a website on economic topics since 2005, at newworldeconomics.com. He has fifteen years of experience in the asset management industry, in research and portfolio management. Today, he is the editor of the Polaris Letter, an investment newsletter.