So What If Tariffs Are Taxes?

Tariffs are back. In the United States, the Biden administration has maintained many of the tariffs imposed on China by President Trump—and added more, including one that prompted a shrieking headline in The Economist: “America’s 100 percent tariffs on Chinese EVs: bad policy, worse leadership.” (Subtitle: “The global trade system is disintegrating as you read this.”)

In reality, the global trade system has already disintegrated, thanks precisely to the policy of appeasing Chinese mercantilism that The Economist advocates. Electric vehicles (EVs) are the perfect example. Using tariffs, subsidies, and other tools of industrial policy, state-supported Chinese firms have exploited access to American innovations and now seek to flood the American market with underpriced exports. Other than the obnoxiously anonymous lead writers at The Economist and a few libertarian dead-enders, who really believes that China’s crushing of the American EV industry would be a “free market” outcome that enhances American prosperity?

The market utopianism that The Economist shares with—and helped teach to—the neoliberal establishment has collided headlong with the market realism that long governed the international economy and American trade policy, and is now returning to its rightful place. Realizing this, savvier defenders of neoliberal globalism are changing the subject from the alleged benefits of cheap imports to the argument that tariffs are “taxes on consumers” and “regressive” ones at that.

The attack on tariffs as regressive taxes unites two of the themes of early twenty-first-century neoliberalism. One is the left-neoliberal dogma that each individual tax—not government policy or the economy as a whole—must be progressive in its effects. The other is the right-neoliberal dogma that deregulating trade and immigration to reduce wages for workers and thus reduce prices for consumers is the “efficient” and thus best policy, as long as the “winners” compensate the “losers”—preferably in the form of redistribution through the tax code.

Both these dogmas should be rejected. The regressivity of this or that specific tax—or even of the tax system as a whole—is irrelevant as long as workers share equitably in the gains from a growing economy and as long as the necessary functions of government are adequately funded. Moreover, while creating “losers” by deregulating product and labor markets is easy, raising taxes on the “winners” to fund higher government spending on the “losers” is politically perilous. And even when it succeeds, such transfer payments prove to be poor substitutes for family-supporting paychecks. If reducing inequality is the objective, the priority should be raising pre-tax wages, not after-tax subsidies. And the best way to raise wages is to boost the power of workers to bargain with employers, individually or collectively, so they can share more of the profits of firms with managers and shareholders in an economy that is growing, in part thanks to the industrial policy that well-designed tariffs can support. Whether the tax code that best achieves that result is a “progressive” one is rather beside the point.

The Return of Market Realism

Market utopianism, in both its radical libertarian and moderate neoliberal forms, recognizes only the legitimacy of voluntary transactions among individuals and firms. Nation-states and blocs have no standing. Any actions by states to favor their own producers over foreign ones is not only inefficient, but also immoral and likely to lead to war. The vision is as appealing as John Lennon’s anthem “Imagine”—and as out of touch with reality. 

Market realism is an element of geopolitical realism, which views the division of humanity among competitive states as permanent and necessary in the absence of a world government. Even without specific sources of conflict, military insecurity drives great powers to seek the maximization of not only their relative military strength, but also their industrial base, on which military power depends, while minimizing their dependency on other hostile or potentially hostile rivals. From a market realist perspective, increasing protectionism in the U.S. and EU is inevitable and justified, as a belated response to the domination of critical industries by authoritarian, mercantilist China. 

Market realism explains the changes that have taken place in American trade and industrial strategy over time. In the nineteenth century, the U.S. 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. By the early twentieth century, protectionism had allowed the U.S. to catch and surpass Britain as the leading industrial nation. Emphasis shifted from protecting infant industries to opening foreign markets to exports from America’s now-mature industries. Tariffs became bargaining chips in reciprocal trade negotiations.

In his message to Congress backing what became the Reciprocal Trade Act of 1934, President Roosevelt made clear that the goal of trade negotiations was to strengthen American industry, not free it to move offshore:

The exercise of the authority which I propose must be carefully weighed in the light of the latest information so as to give assurance that no sound and important American interest will be injuriously disturbed. The adjustment of our foreign trade relations must rest on the premise of undertaking to benefit and not to injure such interests. … From the policy of reciprocal negotiation which is in prospect, I hope in time that definite gains will result to American agriculture and industry.

If World War II had not occurred, the global economy probably would have remained divided among protectionist empires and nations. The U.S. would have retained tariffs as a bargaining chip in negotiations with specific trading partners. But after 1945, the devastation of the other major industrial nations resulted in unrivaled American productive capacity. Fearing no industrial competitors in the near future, the formerly protectionist U.S. became an evangelist for free trade, as Britain had been a century before when the temporary supremacy of the U.K. as the first industrial superpower had seemed unassailable. With the zeal of a convert, Washington pressured other countries to lower tariffs under the auspices of the General Agreement on Trade and Tariffs (GATT), and frowned on the use by independent Latin American countries of the import substitution strategy that the U.S. itself had used only a short time before. 

The American era of global industrial hegemony lasted only a generation. By the 1970s, West Germany, Japan and the “Little Tigers” of East Asia—South Korea, Taiwan, and Singapore—were providing significant competition to U.S. manufacturing. America’s East Asian trading partners unfairly exploited unilateral access to the now-open American consumer market, the largest in the world, while protecting their own domestic markets and fostering their own national champion firms through industrial policy: regulations, targeted credit, and other non-tariff barriers. 

According to the strategic logic of market realism, the U.S. should have abandoned free trade in the 1970s and 1980s and returned, not to infant industry protectionism, but to country-by-country reciprocal trade diplomacy, to prevent the kind of parasitic, free-riding mercantilism practiced by Japan, South Korea, and Taiwan. This was the argument made by proponents of strategic trade and industrial policy in the Carter, Reagan, and Clinton years.

But during the Cold War the logic of American military Realpolitik overrode the logic of American industrial Realpolitik. From the 1950s until the fall of the Berlin Wall, officials of the Pentagon, the State Department, and the National Security Council argued that the sacrifice of some American industries to unfair competition was a price worth paying to keep America’s East Asian protectorates in its Cold War alliance system. When the Cold War ended, giddy triumphalism led American policymakers of both parties to dream of expanding America’s Cold War alliance system to include the entire world. 

The complacent belief in Washington that the “unipolar moment” was in fact a “unipolar epoch” gave permission to American corporations and investors to engage in massive offshoring of industry in a quest for more easily exploitable and thus lower-cost labor, foreign subsidies, and favorable regulations. The result was something unprecedented in history: A great power, the United States, simultaneously deindustrialized itself while allowing and sometimes encouraging its capitalists and corporations to build up the military-industrial power of its most likely geopolitical rival, China.

In the mythology of neoliberal globalism, America’s supposed lack of “comparative advantage” in manufacturing justified and explained its accelerating deindustrialization. In reality, post-Cold War offshoring was driven by corporate labor arbitrage, enabled by the pools of exploitable low-wage labor that China and other countries like Vietnam and Mexico offered to unpatriotic American corporations seeking to evade unions and minimize labor costs. In addition to cheap, unfree labor, China offered Western companies subsidies and also made their relocation to China a condition of access to China’s rapidly growing market. Its integrated strategy lured foreign investment, forced the transfer of innovative technology, and fostered its own national champions.

Americans were shocked to discover their dependence on Chinese-made medical products and drugs during the COVID-19 pandemic. Even more dangerous is the dependence of the U.S. military on Chinese supply chains, now that the cold peace between the U.S. and China has frozen into cold war. “China is now the world’s sole manufacturing superpower,” Richard Baldwin recently observed in VoxEU.  “Its production exceeds that of the nine next largest manufacturers combined. … When it comes to gross production, China’s share is three times the U.S.’s share, six times Japan’s, and nine times Germany’s.” 

Having been indifferent for a generation to the damage done to American manufacturing and American workers by trade-induced deindustrialization, alarm at the prospect of China converting its industrial supremacy into military power and diplomatic influence has finally shocked the bipartisan American establishment into repudiating market utopianism for pragmatic, time-tested market realism.

Sticks, Not Carrots

Despite increasing recognition in Washington of the need for strategic trade in the service of national and alliance industrial policies, tariffs remain stigmatized as a policy tool compared to subsidies. For example, while the Biden administration has largely maintained the Trump administration’s tariffs and imposed some new ones, the core of its agenda has been subsidies—in the form of tax expenditures, loans, and grants—in the Inflation Reduction Act (IRA) and the CHIPS and Science Act. This preference makes no sense. 

As Matthew Klein and Michael Pettis explain in Trade Wars Are Class Wars, China in effect steals consumer and business demand in other countries and gives it to Chinese manufacturers by using government-subsidized overcapacity to run chronic trade surpluses. Tariffs that block Chinese imports are the appropriate and efficient response and can be beneficial even if the result is a “trade war.” While the reshoring of industry has a stimulative effect on the economy of the former deficit country, the former predatory surplus country is left with stranded capital in overbuilt industries, shuttered factories, and unemployed workers who must find new jobs. The result is a forced rebalancing of both economies and of the world economy as a whole.

In contrast, it is profoundly misguided for a country with chronic merchandise trade deficits like the U.S. to respond to subsidized dumping of goods by a trade surplus country like China with countervailing subsidies of its own. A global subsidy race is likely to yield wasteful overcapacity on all sides. Such global gluts are not possible if tariffs are combatting the subsidized dumping by surplus countries. The profit-seeking firms that compete for limited consumer and business demand in a tariff-protected market—including, in some cases, “transplants,” or local subsidiaries of foreign firms—have no incentive to produce more goods than can be sold in the protected market.

While the preference for subsidies instead of tariffs is irrational from the perspective of sound strategic trade policy, it serves the interest of politically powerful special interests. Investors and corporations devoid of patriotic loyalties naturally prefer a system in which multiple jurisdictions—cities, states, nations, or blocs—compete with one another to offer the most generous incentives for investment with the fewest strings attached. Likewise, the same self-interested investors and corporations would oppose tariffs or local-content requirements that force investments to be made in a particular jurisdiction because this precludes a race to the bottom among competing governments. Even if the goal is the same—encouraging the building of semiconductor fabs in the U.S., for example—the power dynamics are quite different, depending on whether subsidies or tariffs are used. Tariffs and local content requirements shift power from the firm to the territorial state and the national community it represents.

To be sure, tariffs designed to reshore strategic supply chains impose transitional and, in some cases, permanent costs, too—on the consumers of finished products, as well as businesses addicted to cheap foreign inputs. But tariffs are not set on fire; they are paid to the federal treasury, which can use them to finance investment, reduce deficits, compensate those burdened, or lower other taxes. The complaint that tariffs designed to localize industrial production are taxes on consumers is particularly absurd when coming from mainstream conservatives and libertarians who favor a national consumption tax, like the American Enterprise Institute’s James Pethokoukis: “Now, the answer isn’t a tariff—a disruptive tax that won’t bring back manufacturing jobs and will hit lower-income Americans the hardest—but more likely a broad-based consumption tax of some sort. (A tariff is a kind of narrow consumption tax).” It’s not the tariff’s taxation they are objecting to, only its market realism.

Indeed, the underlying point made by Pethokoukis and others is correct: consumption taxes have many benefits. But that is an argument for tariffs. The adoption of a general federal consumption tax is compatible with the use of targeted tariffs for both industrial policy and reciprocal trade negotiations. 

Every other advanced industrial country has adopted a national consumption tax, such as a value-added tax (VAT), for compelling reasons. Consumption taxes at the point-of-sale are difficult to evade, allowing revenue to be raised at lower rates. In addition to being all but inescapable, consumption taxes and other taxes like payroll taxes that are collected frequently in small amounts are less likely to cause “sticker shock” and inspire tax revolts than taxes that are collected once a year, like personal income taxes and property taxes. Indeed, precisely because of their tendency to trigger state and local tax revolts by voters, annual property taxes were the only category of taxes in the U.S. to decline in the U.S. between 1970 and 2000, falling sharply from 31% to 18% of state and local government revenue. 

Anarcho-libertarians on the fringes of the right who seek to undermine even limited government, and conservative proponents of a “starve the beast” strategy of forcing spending cuts by slashing federal revenue, often oppose consumption taxes precisely because those taxes can raise substantial amounts of revenue without provoking voter rebellions. 

Sensible conservatives who believe in limited government should want it to be funded by taxes that combine political sustainability with minimal economic distortion, like consumption taxes. Condemning tariffs as distortionary, meanwhile, is question-begging. To the market utopian, who believes trade balances reflect comparative advantage, economic efficiency, and market forces, altering the relative prices of imports and domestically produced goods would indeed be distortionary. But to the market realist who understands the game afoot, tariffs are the least distortionary of all consumption taxes and, indeed, anti-distortionary—offering the rare opportunity presented by Pigouvian taxes to raise needed revenue while improving efficiency and resource allocation.

Justice, Not Progressivity

The resurgence of market realism has left the anti-tariff fundamentalists scrambling for new talking points. If free trade is neither efficient nor good for growth, and supply-side dogma indeed prefers taxes on consumption to taxes on labor and capital, why not tariffs? The closest weapon at hand is the accusation that tariffs are “regressive,” landing disproportionately on lower-income households that can least bear the burden. One answer to this critique is technical, coming down to a question of how the tax system is designed and how various taxes interact. The other is philosophical: Raising the standard of living for most Americans is best done by raising wages and making housing, health, and education affordable, not by tinkering with the tax code.

Taking the technical issue first, 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. For instance, revenue from consumption taxes can also be used to lower other regressive taxes, like payroll taxes. Perhaps even more enticing is the prospect of substituting a federal consumption tax for the income taxes paid by all but the highest earners, in turn paving the way to eliminate many personal income tax expenditures that are themselves highly distortionary and regressive. Tax expenditures, sometimes referred to as loopholes, favor certain activities by shielding them from income taxation by means of exclusions, exemptions, deductions or credits. Economists agree that, as policies to subsidize government objectives, tax expenditures are the functional equivalent of direct appropriations. In 2023, tax expenditures cost $1.8 trillion, more than was spent directly on Social Security ($1.3 trillion), Medicare ($848 million), or defense ($821 million).

Most major individual tax expenditures disproportionately benefit the top 20% of earners. But the way that tax expenditures operate nearly invisibly within the tax code allows favoritism toward affluent individuals that the public would not tolerate if equivalent amounts of money were directly appropriated by Congress. The largest of these giveaways, which overwhelmingly benefit the affluent, are tax benefits for employer-defined contribution plans like 401(k)s ($251 billion), reduced rates on dividends and long-term capital gains ($225 billion), and exemption from taxation for employer-sponsored health insurance ($200 billion), according to the congressional Joint Committee on Taxation (JCT). 

With his “competitive tax plan,” the tax expert Michael Graetz offers an ingenious way to adopt a federal consumption tax while eliminating many or all income tax expenditures that are skewed toward affluent Americans who do not need them. Graetz would impose a form of broad-based consumption tax called a Value Added Tax (VAT) but, in turn, exempt almost all Americans from federal income taxation, returning the income tax to its pre-World War II status as a tax on the very rich only. This would in turn eliminate the political constituency for the top-heavy personal tax expenditures—voters do not care about the mortgage interest deduction if they have no income tax liabilities to reduce. Eliminating personal income tax expenditures would generate much higher tax revenues from the economic elite, who do not need the subsidies, without raising existing personal income tax rates—meeting both the Left’s core objective of ensuring that the highest earners “pay their fair share” and the Right’s core objective of preserving low marginal rates to encourage investment and growth.

Any number of permutations on plans of this sort might be possible. The set of taxes chosen to provide government revenue is a question independent of the progressivity of the resulting code, which comes down to more tactical and technical design choices. 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.

With few exceptions, leaders in both parties today favor the “Hamiltonian” use of government for certain public purposes including infrastructure investment and industrial policy, whether in the interest of national security or climate-change mitigation. But today’s Democrats and Republicans disagree about the proper role of government, with implications for the contours of both taxation and spending.

Contemporary progressives are heirs to a tradition that entrusts wise policymaking in the public interest to nonpartisan, well-informed elites—identified with Puritan divines in the colonial era, with men of property by Federalists and Whigs in the early republic, and with technocratic experts by Progressives in the 1900s. In contrast, today’s conservatives increasingly are heirs to the Jacksonian tradition that was historically identified with the Northern working class and agrarian populists in the South and West.

Reflecting the populist version of democratic republican political theory, Jacksonian thought has typically combined two themes: suspicion of government corruption and support for policies to promote a middling class of producers, whether family farmers or workers or self-employed artisans and business owners. Central to Jacksonian thought about taxation, as about other topics, is rejection of “class” or “caste” legislation that channels benefits to particular groups. Jacksonians prefer simple, clear programs that apply to all citizens in a uniform way. This logic explains why universal social insurance benefits that are earned by work effort like Social Security and Medicare, along with race-neutral antidiscrimination law, tend to be more popular with the American public in general than means-tested programs for the poor only and race-based affirmation action—both forms of “class legislation” by the Jacksonian definition. The argument made by some progressives and academic economists that means-testing all programs could direct more resources to the neediest ignores the fear of many voters that politicians will use targeted “class legislation” to reward their donors and clients with political patronage.

When it comes to raising government revenue, lower- and middle-class voters are rational to identify fairness with proportional or “flat” taxes that apply the same rates to everyone, rather than with progressive taxes that take higher percentages of the income of the rich, if voters doubt the impartiality of legislators. The same determination to minimize abuses of discretion by potentially corrupt policymakers explains why “dedicated” taxes that can be used only for one purpose, like the Social Security payroll tax, are popular with the public, even though they are opposed as inefficient by many technocratic progressives and utilitarian economists.

In his message vetoing the re-charter of the Second Bank of the United States in 1832, President Andrew Jackson expressed a sentiment with which most Americans in his tradition agree: “Equality of talents, or of wealth, or of education cannot be produced by human institutions. In the full enjoyment of the gifts of Heaven and the fruits of superior industry, economy, and virtue, every man is equally entitled to protection by law.” Even the most populist Jacksonians have rejected definitions of social justice as “equality of result,” because a government that was powerful enough to achieve that end would be too powerful to control.

Throughout American history, most Jacksonians have not been satisfied with equality of opportunity alone. They have also favored activist government policies that sought to produce “equality of condition,” identified with a numerically large middle class with the political power to avert the dangers to democracy posed by a powerful aristocracy or a desperately poor underclass. 

In agrarian America, many Jacksonians favored homestead policies designed to create a nation of family farmers, and some supported organized labor and government regulation of railroad rates. In the industrialized, urban America of the twentieth century, equality of condition was defined as the ability of a majority of wage earners who were at once producers and consumers to purchase the basic goods needed for “the American standard of living”—homes, automobiles, appliances—using their wages rather than relying on government largesse. For New Deal Democrats and mid-twentieth century Modern Republicans like Eisenhower and Nixon, different tools could be used to ensure that these basic “merit goods” were available to all working Americans and their families, including antitrust, price regulation, public provision, and low-interest loans, in different cases.

Rejecting this diverse toolkit, neoliberals of right, left and center recently have relied overmuch on redistribution via the personal income tax to reduce mathematical inequality in cash incomes as a substitute for promoting equality of condition. A tariff designed to create a more just economy through interference with the “free” global marketplace is thus disfavored because it doubly sins against both the market’s efficiency and the system of redistribution assumed necessary to compensate for the inequality of the efficient outcomes, without reference to whether the actual condition of the common citizen would be improved.

A neo-Jacksonian approach to political economy in the twenty-first century does the opposite, rejecting the idea of giving government technocrats discretionary power to correct income inequality by targeted laws and policies. It rejects the “root, hog, or die” philosophy of libertarians as well. Its better path—a “third way,” if you will—favors universal policies to grow a middle class of well-paid producer-consumers, with tax policy joining wage policy, trade policy, immigration policy, and others to promote a democratic republican social order with a middle-class majority.