Why We Should Care That Tariffs Are Taxes

by David Hebert

 

In a recent American Compass article, Michael Lind asks “So What If Tariffs Are Taxes?” In doing so, he defends the position of so many on the left and right that tariffs are good economics, good policy, and essential to reverse the damage allegedly caused by zealously pursuing trade liberalization. Unfortunately, he gets both his history and economics wrong. Because of these errors, his policy recommendations are misguided and reflect an antiquated, pre-Adam Smith view of the world that promotes mercantilism, cronyism, and a “beggar thy neighbor” approach to international relations. These policies have been tried before, with the same result each time: the impoverishment of the nation and its people.

Lind’s call for “Sticks, Not Carrots” belies a subtle truth: he believes it is the federal government’s responsibility to make sure that Americans are well-off. This starkly contrasts the historical position of the American Right up until the 2010s, not to mention a core principle of the American Founding: our well-being is primarily our personal responsibility.

The carrots Lind wants us to cease using are “countervailing subsidies” in response to China’s “subsidized dumping of goods.” Were his call to end subsidies to US firms the end of his policy proposals, Lind would have a leg to stand on. Instead, he advocates the use of sticks—via tariffs—to punish American consumers for purchasing foreign-made products. This is not just bad policy. It is economic lunacy.

The fundamental problem for Lind is that the respective track records for trade liberalization and tariffs are in. Trade liberalization works. Tariffs don’t.

To support his critique of trade liberalization, Lind argues, “In the nineteenth century, the US pursued a successful import substitution strategy that transformed it from an agrarian to an industrial economy with the help of tariffs that kept out manufactured goods from Britain and other more advanced economies, reserving America’s growing home market for American-made goods.”

Unfortunately, Lind provides no sources to support this claim. But there are plenty of sources arguing the opposite. Samuel Gregg, for example, offers one such critique. Douglas A. Irwin has likewise explored the question empirically, and finds that “evidence in favor of the import substitution view [of American economic history] is weak.”

The implications of Lind’s mistaken grasp of American economic history are two-fold. First, it misleads people into believing that the failure to “protect” American firms from foreign competition has led to the manufacturing declines we see today. The second is that many will mistakenly believe that applying tariffs and industrial policy to American industries will somehow re-shore manufacturing jobs, boost pre-tax wages, and bring about more economic equality.

Both claims are empirically false and belie a failure to grasp even the basics of Econ 101.

First, about 90 percent of the job losses during the China Shock from 2000–12, which saw cheap Chinese imports flood the US market, were the result of technological change, not imports. This made manufacturing workers more productive, not less. For example, according to the same study, automotive workers are today almost twice as productive as they were in 2010.

Yes, it takes fewer people to produce a car today thanks to technological progress compared to 2000. But Lind fails to recognize that the car industry will only employ the same number of people that it did in 2000 if consumers wish to purchase commensurately more cars. The same can be said of all industries: when workers are more productive, there will be fewer workers employed in that industry over time unless sales also increase.

Lind also ignores the fact that these changes have meant that many people who would otherwise be employed in the automotive sector are now more usefully employed serving their fellow Americans in other industries. It is that higher productivity that translates into higher wages, not increased “power of workers to bargain with employers,” as Lind claims.

Turning to Lind’s second claim: protecting American industries through tariffs has not achieved its stated goals. The 2019 Economic Report of the President, written by President Trump’s own Council of Economic Advisors, confirms that the 2018 tariffs on steel and aluminum did not lead to any beneficial changes in Chinese trade policy. More damaging, a 2019 Federal Reserve analysis illustrates that the tariffs imposed under Trump’s leadership were “associated with relative reductions in manufacturing employment and relative increases in producer prices.”

Why is this? While a few jobs may have been saved in the steel and aluminum-producing sectors, these were “completely offset” by job losses in the steel and aluminum-using sectors. Tariffs raise prices and, in response to higher prices, firms in the industries using the now more expensive materials cut costs in the form of laying off workers.

In other words, tariffs cause higher prices, particularly for low-income households, and reduce employment in the very sector that tariffs are supposed to protect: manufacturing. This makes tariffs a regressive tax in that the burden falls disproportionately on low-income households. Lind chides scholars who make this claim, almost as if they are grasping at straws, clinging desperately to an outdated ideology. To refute this, he says, “One answer to this critique is technical … the other is philosophical.”

His technical critique is simple: “What matters is the progressivity of the federal-state-local tax system as a whole, not ensuring that every tax at every level is progressive.” This is immediately followed by a discussion of changes that could be made to reduce the overall regressivity of the federal-state-local tax code, ignoring the argument that tariffs are regressive.

His philosophical critique of the claim that tariffs are regressive is even more absurd and contradicts his technical critique. He writes, “But a philosophical issue also arises. The tax code’s progressivity is not an end unto itself, it is a compensatory mechanism for addressing a distribution of gains in the economy that the nation regards as inequitable” (emphasis added). The reader is left as confused as Lind is in economics. Does progressivity of the tax code matter or does it not?

Tariffs cause higher prices, particularly for low-income households, and reduce employment in the very sector that tariffs are supposed to protect.

Because he brings up the argument about tariffs being regressive but never actually argues against it, the only conclusion can be that Lind accepts that this is true but thinks, as he does about tariffs being taxes, “So What?”

Since tariffs are regressive in their application, which there is ample evidence that they are, then removing them would also be regressive and disproportionately benefit low-income families. If Lind is serious about “increasing pre-tax wages” and “reducing inequality,” then he needs to look at reducing barriers to trade, not erecting new ones.

Another problem with Lind’s argument is his misleading use of several sets of statistics and various reports. For instance, Lind points us to a VoxEU study which states that “China is now the world’s sole manufacturing superpower. … Its production exceeds that of the next nine largest manufacturers combined.” This is true. If we compare the manufacturing output of China and the US, for example, we do find that Chinese output is about triple of US output.

This sounds alarming until one realizes that China has about six times as many people as the United States. If we exclude India, China’s population is so large that it exceeds the combined populations of the remaining eight countries included in the statistic. In other words, China’s impressive manufacturing output is entirely driven by their high population, not their economic prowess.

Likewise, a Peterson Foundation article to which Lind points out states that “tax expenditures cost $1.8 trillion” in 2023 and that “tax appropriations are the functional equivalent of direct appropriations.”

There are many problems with Lind’s use of this article. First, the very name “tax expenditures” is itself pejorative and misleading, even if it is widely used. In the article, the Peterson Foundation uses the example of the mortgage interest deduction as a “tax expenditure.” For anyone who owns a home, the mortgage interest deduction is a wonderful tax advantage. Were this law to be repealed, the tax bills of homeowners would indeed increase. But despite Lind and the Peterson Foundation claiming otherwise, this is not the same as the federal government giving homeowners money. That would be known as a “post-tax subsidy.” The logical conclusion of Lind’s and the Peterson Foundation’s arguments is tantamount to saying that the federal government is the actual proper owner of all of our income, with taxpayers enjoying whatever the government deems appropriate to give back to us.

As a definitional matter, taxes are a revenue source for governments. “Tax expenditures,” according to the Peterson Foundation, “come in a variety of forms including … tax exclusions, tax exemptions, tax deductions, and tax credits.” Calling these “expenditures” is as misleading as claiming that reducing government spending is equivalent to increasing tax revenue.

Second, the word “functional” is doing more work than Lind realizes. While taxing someone, say, $100 less might, under certain conditions, be functionally the same as giving them a $100 subsidy, the two reflect vastly different characteristics.

Allowing the private sector to keep more of its pre-tax dollars through so-called “tax expenditures” represents a form of humility. It amounts to a government saying, “We don’t know how to use these dollars better than the private sector.”

Conversely, granting post-tax subsidies reflects arrogance. It is the federal government using dollars that it has previously taxed and deciding, through the political process, that its use of the money is better than what the private sector would have done with them.

This is illustrated by the track records of governments that tax too much and attempt to steer society toward specific economic goals. Generally, they produce less prosperous and less dynamic economies. Government planning simply cannot replicate the ways free prices in a free market allow businesses to deliver the goods that people want at a cost they can afford.

Because of this, “tax expenditures” are not the same thing as “direct appropriations.” If anything, we should expand the use of so-called tax expenditures and allow private companies to keep more of the money they earn, not less.

All of this confirms one thing: Lind’s dismissive, “So What?” about tariffs being taxes reflects a shallow grasp of basic economics. Taxes do not promote economic growth. They inhibit it. And given that tariffs are taxes, they have the same effect on the economy as any other tax. In short, we need to reduce tariffs and promote trade liberalization, not impose new costs on domestic consumers and producers.

Doing so will help further increase worker productivity, which is the true source of the higher pre-tax wages Lind wishes to promote. What’s more, because tariffs are regressive in application, removing tariffs would also be regressive and disproportionately benefit low-income households, thereby reducing inequality. Removing barriers to trade, not erecting new ones, is the best way forward.

 

 

THIS WAS ORIGINALLY PUBLISHED ON LAW & LIBERTY ON AUGUST 13, 2024