Determining tariffs’ impact a taxing task
Tariffs and trade negotiations have been at the top of world economic news the last few months, and you can expect more! On May 29 the Trump administration announced that it was proceeding with tariffs on $50 billion in Chinese imports and has allowed the steel and aluminum tariffs previously announced to move forward for our allies—the European Union, Canada and Mexico. Why all the news, why all the concern and should we be worried?
These issues are of no surprise. Trump’s campaign was full of promises to impose tariffs and withdraw from NAFTA and the TPP to correct what he called “bad deals” and unfair trade practices. Now that he is proceeding down this promised path we have many government, business and economic leaders raising alarms. The billionaire Koch brothers, who generally support President Trump, announced that they will spend millions campaigning against the new tariffs.
Free trade between nations is supported by economists, who suggest that the practice makes everyone better off, as each country has different resources and abilities. Free trade allows each country to produce what it does best and then obtain the other products from trading partners. The logic is no different than a farmer who grows corn but buys his tractor from others, who in turn buy his corn. In this arrangement, everyone ends up better off.
Economists point back to the Smoot-Hawley tariff of 1930 and the accompanying trade war, which reduced U.S. imports and exports by about half and is widely agreed to have prolonged and exacerbated the Great Depression. Last year in the United States, we imported about 15 percent of the value of our total domestic production and exported about 12 percent. At this size, imports and exports are big enough to have a huge impact on our economy.
Of course, the fact that we import more than we export means we have a trade deficit, and this is the source of
Trump’s concern. Economists tell us that these deficits should be self-correcting, but their theories have not worked out, as the U.S. has had a trade deficit since the 1970s.
As with all economic issues this should be viewed through a lens of winners and losers. For example, when we have tariffs on imported steel then U.S. steel manufacturers can charge a higher price and will benefit. However, U.S. consumers will suffer because of having to pay more for anything manufactured with steel. As a result of the higher prices, there will be less demand, and overall production and jobs will decrease. Winners: U.S. steel companies and employees; losers: all consumers and the national economy.
There are a number of valid reasons for tariffs, most of which involve what could be called unfair competition. For example, if we believe as a country that child labor should be outlawed, it would be unfair to have our businesses compete with companies from another country using cheap child labor. The same is true for pollution. If we believe that a company must practice a certain level of costly pollution control but then we allow free trade with a country that doesn’t practice this same pollution control, their products will be unfairly cheaper and our citizens will lose their jobs, but the pollution will still occur—just in the other country. This takes place now with rare-earth minerals used in modern magnets and electronics. Most rare-earth minerals are mined in and exported from China. It is not because we don’t have the minerals in the United States; we do, and we previously produced them, but the specific mining techniques require excessive and damaging pollution, so in our country they are too expensive to mine. These pollution-control restrictions have not been enforced in China.
Another valid reason for tariffs is unfair government support. Remember that economists tell us that a trade deficit should balance itself over time. One reason the deficit might not correct itself is if a country practices currency manipulation. This would occur when instead of letting its currency be valued by the free market, it defines the currency exchange rates by law. This has been one of the main complaints against China, that in fact, they artificially keep their currency too cheap resulting in cheaper-than-natural export prices. As a result, China’s employment stays high, and then China, with the extra U.S. dollars it accumulates as a result of the trade deficit, uses those dollars to invest in the United States. They buy U.S. farms, businesses and treasury bonds and this gives them some influence in our country’s economic and government operations.
Another valid reason for tariffs is to fund the government. These are taxes, and taxes are needed. In the early days of the United States, prior to income tax, tariffs were the most important source of funding for the federal government. Today, we obtain relatively little of our government funding from tariffs. All taxes, of which tariffs are included, have unintended consequences. An interesting example involves sugar. You may be aware that the U.S. government subsidizes domestic sugar production by limiting imports. We pay almost twice the world price for sugar in the United States. Who benefits and who is hurt? Well, clearly the large commercial industrialized sugar farms benefit. We as consumers all pay more and are hurt. At one time, a major candy company figured out a way to get around this “tax”. They bought world-price sugar in Mexico, formed it into large blocks and then shipped the blocks into the United States, tax free, as a manufactured product (restrictions were just on raw sugar). They then paid to have the blocks broken up back into sugar granules. A lot of extra effort and inefficiency resulted because of the tax. This tells us that tariffs may not be an efficient source for taxes.
All the trade negotiations going on right now are very significant and will, in one way or another, impact you personally. Some countries such as Germany (46 percent), South Korea (40 percent) and China (20 percent) have built their economies on exports. We have not, but still tariffs and trade wars run the risk of messing with a large part of our economy. The most likely areas that could be negatively affected are agriculture and manufacturing. Even if changes do not directly affect your job, the ripple effects and higher prices eventually will move your way.
The United States has been running a trade deficit since the 1970s, so something needs to change. If other countries are not honoring the same labor, safety regulations, pollution controls and free currency as we do, then they are not competing fairly. If this goes on for long periods of time, then we as a country are hurt.
In the end, the current discussion with our trading partners could result in some good and much-needed change. But it is also possible that a lot of damage could be done. Hopefully, both we and our trading partners will proceed with caution and wisdom to find a way that free trade can make both of us richer.