Are Tariffs Taxes on Consumption or Production?

Generally speaking, in economics consumption takes are less disruptive than production taxes.  Since people produce to consume, if a tax falls on production then it reduces production which in turn reduces consumption.  Conversely, if a tax falls on consumption, it can have less of a negative effect.  Tariffs are sometimes defined as a consumption tax, and thus would appear to be preferable to a tax on production like a corporate tax rate or capital gains tax.

Whether or not a tariff is preferable to corporate taxes or capital gains tax would be an empirical question, and one I am not interested in answering at this time.  Rather, I want to push back on the definition of a tariff as a consumption and not production tax.

Much of the US’ imports are of raw/intermediate/capital goods (I forget the exact statistic off the top of my head, but I believe it’s around 55-60%).  Since these are used in the production process, a tariff is necessarily a tax on production.

But what about the other 40%, the consumer goods?  Would a tariff be a tax on production here as well?  I’d argue “yes.”  This is a little counterintutive at first: why would a good imported into the US and sold to consumers without some manufacturing done to it be considered production?  Let’s take a look at the definition of production (emphasis added):

Production occurs when the physical characteristics of resources are improved.  Although we commonly think of production as changing the form of material–from ores to steel, from steel to cars or I-beams–production also includes improving the time of avalibility or location of a good.  moving water from a well into a house is productive, as are carrying coal from a mine to a furnace; tilling the soil, planting seeds, or caring for the crop; harvesting, cleaning, grading, transporting, preserving, and distributing the crop to retail stores; or advertising, wrapping, and delivering a good to the customer’s home.  (Source: Page 136)

Imports enter the US in some port (LA, New York, Boston, etc).  They then must be transported to warehouses and retail stores before they can be consumed.  Since transportation is part of production (it is improving both the time availability and location of a good), then a tariff necessarily is a production tax since the goods are used in some form of production.

Again, whether or not a tariff is preferable to other kinds of taxes is an empirical question.  The point of this post is to discuss a terminological issue.

Can Protectionism/Scarcityism Encourage Industry?

Short answer: not likely

Long answer: Protectionists Scarcityists like to argue that protectionism is needed (or can otherwise) to encourage industry.  Foreign competitors use “unfair” practices to undermine the domestic industry and protectionism scarcityism is there to protect the industry from these shenanigans.  This, in turn, will foster more domestic investment and encourage industry.  But how likely is this to be?  Let’s take a look at the logic.

From a protected industry perspective, it is possible that scarcityist policies encourage some investment in that protected industry.  Domestic production increases (although this is merely a substitute for some of the imports and overall output decreases).  This increased production may encourage more investment, but it is hardly guaranteed to.  These protected industries are protected from competition, so there isn’t much incentive to invest and improve; they are output restrictors.

Enlarging our view to the economy as a whole, scarcityism is far more likely to reduce investment and industry.  As I pointed out above, scarcityism works because it reduces output, forcing prices to rise.  This necessarily means consumers have to spend more to achieve the same standard of living.  In turn, this means fewer savings and since savings are funds used for investment, this means less investment.*  Additionally, since imports are reduced, foreigners now have fewer dollars with which to buy exports or invest in the US economy.  Reduced savings, and thus reduced investment, comes from this area as well.

There are secondary effects of scarcityism as well.  Not only does it reduce overall output in an industry, it encourages the use of wasteful use of current resources.  The protected firms are using less efficient methods of production, which is eating up resources that could otherwise have been released for more valuable purposes.  This, in turn, means fewer resources for industry to use and grow.

In order for scarcityism to foster growth, it’d require an awful lot of luck and some highly specific conditions which are improbable in the real world.

*Note that this same logic holds even if consumers switch to a cheaper substitute for the now-more-expensive goods.

What’s the End-Goal?

Commenting on this blog post at Cafe Hayek, Donald Jansen writes:

Yes, yes, protectionism is evil. Still. The government needs revenue. Why are tariffs inferior to other taxation schemes? During the many decades of US history in which the tariff was the primary means of financing the US government, the federal government’s share of GDP consistently averaged 3%. Who would not gladly prefer those circumstances over what we have today?

Below is an extended response to him I left:

To the extent a government is desirable, it will need to be financed. To that end, you want a tax, whatever it be, that’ll maximize revenue while minimizing costs. In other words, you’d want the lowest tax rate possible to finance the government.

But note that an optimal tax is a fundamentally different beast than the tariff discussed here. Don is discussing protectionist tariffs, tariffs not meant to fund government but meant to control behavior. The “butwhatabouts” want tariffs to “protect” industry, not to finance government. They want it to achieve some goal different from finance. To that end, the tariff is more likely to be harmful than helpful (barring an extreme set of assumptions).

Understanding the end-goal of an action is important when it comes to discussing the action.  If the goal of a tariff is to fund government, then it will be radically different than a tariff meant to discourage imports.  The former will try to keep imports as high as possible.  The latter wants to keep them as low as possible.  While both beasts have similar names, they have quite disparate goals.  it makes no sense to object to the argument against a protective tariff by pointing out the theoretical benefits of an optimal tariff; it’s comparing apples and oranges.


Today’s Quote of the Day…

…is found in a letter from Frederic Bastiat to Richard Cobden (leader of the Anti-Corn Law League) dated 8 April 1845.  The letter can be found on page 58 of the Liberty Fund’s collection of Bastiat’s correspondence, The Man and the Statesman (emphasis added):


Since you have permitted me to write to you, I will reply to your kind letter dates 12th December last.  I have been discussing the printing of the translation [of Cobden’s speeches and pamphlets] I told you about with M. Guillaumin, a bookseller in Paris.

The book is entitled “Cobden and the League, or the Campiagn in England in Favor of Free Trade.”  I have taken the liberty of using your name for the following reasons: I could not entitle this work “The Anti-Corn Law League.”  Apart from the fact that this would have a barborous sound for French ears, it would have brought to mind a limited conception of the project. It would have presented the question as purely English, whereas it is a humanitarian one, the most notably so of all those which have brought campaigning to our century.

By presenting the issue of free trade as a humanitarian issue rather than a sectarian or nationalist issue, he demonstrates the universality of the principles of free trade.  Many opponents of free trade like to argue that free trade is conditional.  They may argue that free trade requires “transnational rule-making institutions.”  Or that trade only is good if one nation (ie the nation of the speaker) benefits.  Or that free trade needs to be “fair” (whatever that means).  But Bastiat makes no such prerequisites.  Bastiat and Cobden both argue that free trade is not an English concern, not a French concern, not an American concern, but a human concern.

The Anti-Corn Law League that Cobden was part of was founded in opposition to the Corn Laws, a series of mercantilist legislation that raised the price of food within Great Britain by restricting imports.  Given this legislation occurred at the same time as the Irish Potato Famine, the Corn Law, by artificially increasing scarcity of food, likely caused many deaths in Ireland from the famine.  The Corn Laws contributed to a humanitarian crisis.  We are seeing similar situations going on in Puerto Rico, where scarcity is increased because of the Jones Act, and Houston and Florida where scarcity is increased because of anti-price-gouging legislation.  Free trade is a humanitarian concern, not a sectarian concern.

Let’s Talk Taxes

Seemingly every 2-4 years, the Federal Government starts talking tax reform.  The same talking points are repeated over and over: high tax, low tax, red tax, blue tax.  But from an economic standpoint, taxes are much more subtle.

The standard economic story of taxes is fairly simple: as the price of something goes up (in this case, the price increase is due to taxes), you get less of it.  Higher taxes on labor (income tax, payroll tax, etc) discourage labor.  Higher taxes on cigarettes discourage smoking.  Therefore, many economists argue, taxation should be as low as possible.  Therefore, tax cuts can stimulate economic growth.

However, taxation does go to support government and institutions like stable property rights (under which I am classifying law enforcement and national defense), courts, and the like.  Other economics argue these institutions encourage economic growth, so taxation should be relatively high to fund and develop these institutions.  So tax hikes can stimulate economic growth.

Both arguments are reasonable and not mutually exclusive.  There is likely some optimal level of taxation necessary to promote desirable institutional development without being a net drag on the’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?

Let’s say that the economy is beyond that optimal point of taxation, that the current level of taxation is too high and is a net drag on the economy.  Does it immediately follow that taxes should be cut to stimulate growth?  I argue no.  If taxes are cut without regard to spending, that is taxes are cut and deficits emerge, then it won’t do much to stimulate growth.  This is because people are rational and forward-looking.  If taxes drop and deficits rise, then people will realize that, at some point, those deficits will need to be covered, either by higher taxes in the near future, or by government borrowing, which means higher taxes down the road.  People will begin to prepare for these higher taxes by saving more in the meantime knowing they’ll have a higher tax bill coming.  In short, there would be little (if any) effect on the economy from the tax cut; it’ll be no different than if there had been no cut at all.

However, if the tax cut were permanent, that is coupled with a cut in spending so that there is no deficit, then the cut would likely have a more positive effect.  Knowing (to the extent they can) that taxes won’t rise means they see their higher amount of kept income not as a temporary thing, but as a permanent change.  The tax cut would have a more stimulative effect on the economy.

When discussing taxation, it’s important to remember that deficits matter, too.  A tax cut that only generates deficits won’t have the same effect as a tax cut that does not generate deficits.