Let me start by saying that all things being equal tariffs are bad for the average America.  The problem in the real world is that not all things are equal.  The government is going to raise revenue somehow, but there is a choice in how to do it.  The categories are relatively simple

  • Fines
  • Head tax (everyone responsible for the same number of dollars)
  • Usage fees (federal leases, toll roads, registration fees, etc)
  • Tariffs (putting taxes on foreign goods/services entering the US)
  • Wealth tax (real estate, wealth, inheritance, etc)
  • Income tax (capital gains, income, wages)

Fines and head taxes are generally agreed to be a fairly repugnant way of raising revenue that both lead to mistreatment of the poor.  Usage fees are generally agreed to be pretty good ways of raising revenue, but if you raise the cost of an oil lease high enough nobody will pay it and you have less revenue.  The usage fees simply are not sufficient to run our current government*.  That leaves taxing imports, wealth, and income.  The problem is that capital (money available to build new stuff) will react to any taxes.  If I can build a shiny new factory in either California or Texas I am likely to build it in Texas simply because the state of Texas will charge me less.  Let’s consider the three taxes above, taxing what you have (property tax), what you earn (income tax), or what you import (tariffs).

Tariffs

Tariffs raise the cost of all goods and services entering the country.  This includes parts in pretty much everything that you buy (except food, but it does include the equipment needed to farm).  If tariffs are raised the cost is eventually passed on to everyone who buys stuff.  However, the tariff can be reduced by simply buying less stuff.  I know that sounds sacrilegious, but there are very few people who have simple too few things in the US today.  If most of us had to cut 10% of our purchases or die we would probably be able to manage the change with minimal disruption to our lives.  However, there is another option…  Let’s say I manage the supply chain for WalMart and I know that the cost of mop heads imported from China will go up 25%.  I also know that there is a mop head facility in Mexico that costs 7% more per mop head, but will not face the tariff.  I can shift the supply chain from China to Mexico and pass on a 3% cost increase (the cost of goods is probably ~50% of the retail price).  Alternatively I might find an American supplier that costs 20% more (assuming no Mexican or Brazilian options exist).  Now my cost goes up 10%, but on the other side of that equation is an additional employed American.  The capital now remains within our borders leading to lower profit margins (investors can insert their “boo’s” here), but greater national wealth.  This is generally derided as “protectionism” but when your economy is 25% of the globe you probably want to protect that.

Wealth Taxes

This is a fairly broad category.  I lump all wealth together because you can always trade real-estate for bars of gold or stocks.  This taxes your current value.  This is the current favorite of people like Elizabeth Warren and Bernie Sanders.  This is probably the most destructive form of tax for running a large government because… well we will see why.  Let’s say that I am CFO for Caterpillar.  I can put a new factory in either Iowa or Canada.  Both locations allow easy transportation to my clients, both have a good workforce, there are no tariffs between the two, and both have stable infrastructure.  However, Iowa now has a property tax that will cost me 3% per year, and Canada has a 1% tax.  The easiest thing for me to do is place the factory in Canada and bank that 2% as profit.  The problem is that capital can move.  Here I used the example of a factory, but the move is even easier for financial assets.  This is exactly why so many companies are sitting on piles of overseas cash and not reinvesting domestically.  If they decide to invest in America we are going to hammer them with taxes.  If they invest in Vietnam they are not taxed.  Are there any exceptions to the awfulness of property taxes?  Yes. Government services that are locally provided, equally beneficial to everyone, and applied to real-estate.  This would include things like firefighters, police departments, education systems, roads, etc.  You can’t manage having workers anywhere without these types of services, so those are appropriate to put on local real-estate.

Income Tax

This is our current largest source of government revenue.  This includes things like capital gains, wages, and income.  Effectively it is “what did you make last year, now give me 30%.”  Let’s imagine I run Apple and I can hire programmers in San Francisco or Beijing.  In San Francisco I have to include in the pay package both the take home salary and all the additional income taxes.  This is because your typical programmer will base their decision on take-home pay rather than incentive package.  However, that local income tax eats away at the take-home pay.  This is why companies like Toyota are moving headquarters to Texas – they can substantially improve take home pay without raising the compensation package.  Again, company investments will seek to build where their tax burden (including the burden on their employees) is the lowest.  We tax income as high as we do for three reasons 1) Our government does a ton of stuff 2) We don’t import enough to put the entire burden on Tariffs even if we wanted to 3) If we put the burden on property we would quickly see capital flee from the US altogether.

Wrap-up

A tariff introduced simply to block foreign goods are generally bad.  However, given a choice between the three categories tariffs are probably the least destructive option to our national economy.  We did not elect a president of the world, we elected a President of the United States of America.  If the tariffs disrupt trade and cause China or India a lot of pain then so be it.  It is really their problem.  Yes, if we could lower the burden of government as a whole that would be good, but until that happens switching taxes to the least destructive form is probably a net good.   This is independent of other tariff arguments (retaliation for IP theft, it is generally a bad idea to fund your enemies military expansion, other countries are involved in currency manipulation, etc.).  What I am arguing is that tariffs are less destructive to capital investment than either wealth or income taxes.  Tariffs penalize importing goods built on foreign capital while wealth taxes penalize owning capital, and income taxes penalize generating value.

* I do not believe that our federal government is right sized.  I think we could manage on ~15% of what we do, but that is a discussion for a different day.