The resurgence of tariffs as a major component of American fiscal policy is one of the central upshots of the Donald J. Trump presidency. For decades previously, tariffs were a boutique element in the realm of taxation, almost exclusively the province of small-stakes lobbying and Congressional favor-granting. Now tariffs are soaring past the levels of sales-tax rates in center-left countries, and they are aimed at the United States’ most major trading partners, especially China.
Here comes the capital surplus. Photographer: Krisztian Bocsi/Bloomberg
This has occurred as the president has courted the favor and advice of supply-siders, those responsible for developing or maintaining the theory of tax-rate cuts and monetary stability associated with the Reagan revolution in economic policy. Supply-siders have long been part of the free-trade camp, or so it is assumed. The disorientation the administration’s large moves in the tariff area calls for a renewed examination of the role of tariffs in supply-side economics as this tradition has developed over the past sixty some years.
A defining concept of supply-side economics was that often enunciated by Robert L. Bartley, the nonpareil editor of the Wall Street Journal of the late 20th century. This was that “the only economy is the world economy.” Bartley got this notion from the theoretical lodestar of supply-side economics, the Nobelist Robert A. Mundell, whose views on tariffs and trade formed the basis of supply-side thinking in this area.
Mundell burst on the scene as a wunderkind trade economist in the 1950s, publishing papers on the subject in the top journals as an MIT graduate student. Revisiting several observations of these papers provides an outline of the early the supply-side position on tariffs.
One of these was: “There are two analytic methods of treating the disposition of tariff proceeds….We may assume that the government spends the tariff proceeds,…or we may suppose that tax proceeds are redistributed as income subsidies to consumers. The latter method…is used here.” Another was: “tariffs will stimulate factor movements. Which factor [labor or capital] depends, of course, on which factor is more mobile.”
From these two observations we might discern the course of supply-side doctrine on tariffs as it became ever more elaborated from the 1960s until today.
The first observation implies that tariffs must involve some kind of tax substitution. If a state gets more money because of the revenues involved in tariffs, then other tax burdens have to go down in order for government not to get larger. In his initial example, of subsidies to consumers, Mundell determined that these would raise government revenues care of domestic sales and income taxes. As Mundell continued to ponder these issues over the years, he urged a cut in American income tax rates.
From the beginning of the supply-side tradition, and intensifying as it matured, it has been a central point of doctrine that if there are to be tariffs, there must be fully commensurate cuts in other forms of taxation. If, furthermore, the current tax burden is too high, then the imposition of tariffs must coincide with other tax decreases of a much greater extent.
The bombshell that refocused supply-side thinking on tariffs was Bartley colleague Jude Wanniski’s 1978 book The Way the World Works, which made a stunning, and never-refuted argument that the Smoot-Hawley tariff of 1930 was the proximate cause of the Great Depression. Wanniski, who knew Mundell well, pushed Mundell’s argument into the case where tariff increases are so high that they lead to less revenue and thus, in turn, more increases in domestic taxation to make up the difference.
Wanniski incorporated the Laffer curve into his comprehensive analysis of tariffs economics. If tariffs are already near the wrong side of the curve, raising them could occasion taxation in all realms, including domestically, beyond control. Indeed, in the early 1930s, the tariff and the income tax were sequentially raised. The tariff was raised, and lower revenues came in. As a result, the income tax (and the inheritance and gift tax, etc.) was raised, and because of that, lower revenues came in. The Great Depression was the singular result.
Wanniski compelled supply-siders to focus on the bird-in-hand. Take free trade and concentrate all efforts on lowering domestic tax rates. Do not compromise by having a broader tax base via low income-tax rates and low tariffs—which theoretically is more economically efficient—because the political process is too fickle to handle it. If there is consensus, in the broader policy world, for free trade, take it and kill off the income tax and the capital gains tax with all your strength.
Thus the supply-siders entered the Reagan era as free traders, even though the original Mundell position would have permitted them to cut domestic tax rates under the auspices of a modest tariff. But with the top rate of the individual income tax still at 50% after the first Reagan tax cut, and the inflation-unindexed capital gains rate as high as 28% after the second, supply-siders never found reason to introduce tariffs in the name of broadening the tax base in exchange for net lower rates.
Since the 1980s, the top rate of the individual income tax (inclusive of mandatory add-ons) has hung around 40%, which is where it is now, after the 2017 tax cut. This rate is palpably too high to justify any kind of switch into tariffs. For supply-siders to accept tariffs on economic grounds, that rate would have to fall to something like the top corporate rate of 21%.
As for that corporate rate, it is not as low as it appears. When it was lowered from 46% to 34% in the 1980s, it occasioned the demonstration effect whereby corporate rates went down globally in a competitive spirit. This made the U.S. rate the highest by 2017, when it was cut. Today U.S corporate tax rates are near the global average.
Therefore, what the current fiscal policy mix presents to the supply-siders is tax-rate cuts on the corporate side of a moderate variety and ex nihilo tariff increases. In a simple sense, this is no change from the status quo ante, zero-sum. In another sense, it is possibly inclusive of economic efficiencies because there are net lower rates on a broader base.
Yet the supply-siders consider the status quo ante, the President Barack Obama economy, as having badly underperformed. Therefore something more than slightly better than zero-sum would be the necessary policy response. It is telling that while growth is clearly higher than under Obama, it is struggling to clear the mythical 3% mark. This is consistent with supply-side foresight. Swap a domestic tax-rate cut for a tariff, and at the most there will be some bounded efficiency gains.
On Mundell’s other central point from the 1950s – that tariffs will stimulate factor movements, altering the optimal labor/capital ratio – the broken American immigration system interposes a barrier to this natural process, which the tariffs have engaged. This leads to efficiency losses in the economy, another culprit in growth currently being decent, not stellar, which a full application of supply-side economics is supposed to procure.
