By: Peter Schiff, President and CEO Euro Pacific Capital
Donald Trump’s critics have heaped scorn on his calls for protective tariffs to deal with America’s widening trade imbalance and the resulting loss of higher-paying blue color jobs. Some have accused him of trying to turn back the clock in pursuit of a cheap populist ploy and have said that he simply refuses to acknowledge that America is now an information and service economy for which large trade deficits are the new normal. But voters are sensing that The Donald is right to sound alarm bells, and that something radical needs to be done to revive manufacturing to make America great again. But his tariff solution is hardly the best medicine. To be honest, given the even worse solutions that are being offered by the left, Trump’s instincts may be preferable.
Ironically, in the late 19th and early 20th Centuries, the elimination of tariffs was a populist issue. A little more than a century later, the polls have reversed completely. Prior to the introduction of the income tax in 1913, tariffs were the Federal Government’s principal source of revenue. During the long and contentious campaign to enact the 16th Amendment (which allowed the government to tax incomes for the first time since the emergency Civil War-era 3% to 10% income tax), proponents argued that the passage of a “soak the rich” income tax would allow the government to repeal the tariffs and thereby transfer the tax burden from the working class, who paid the tariffs through higher prices on imports, to the ultra-wealthy, who were the sole target of the income tax as it was originally conceived, packaged and sold.
(The tax originally imposed rates from 1% to 7%, and only applied to fewer than 1% of Americans. The 99% supported its enactment solely because they believed they were getting something for nothing, in this case, government services paid for by the rich. In fact, in 1895, when the Supreme Court bravely declared the government’s first attempt to replace tariffs with an income tax unconstitutional, the justices were personally vilified as defenders of the rich.)
But once the Federal Government got its foot in the door, it rapidly raised the tax rates and expanded the base of taxpayers, ultimately subjecting the middle class to rates far higher than anything originally contemplated for the Rockefellers, Carnegies, or Vanderbilts. If this does not provide a sterling example to the legions of Democrats “Feeling the Bern” of how class warfare can backfire on the class waging the war, I don’t know what does. Ironically, no single tax has done more harm to the middle class than the income tax.
So while the populist movement of the early 20th Century demanded the removal of tariffs, the populist movement of today wants to bring them back. But Trump is not talking about replacing income taxes with tariffs. He simply wants to add tariffs to the existing tax structure (though he does want to lower the rates). This will only compound our problems and make our economy far less competitive. It will not bring back our jobs; it will only increase the tax burden on the American economy, destroying even more jobs. If we want to undo the deal we made with the devil over 100 years ago, we need to repeal the income tax as well.
If that substitution were on the table, I would argue that tariffs offer the lessor burden. Tariffs are a much simpler form of taxation that do not require armies of accountants, lawyers, and tax preparers, who are needed to comply. And while we are repealing the income tax, we should repeal most of the other federal taxes (particularly the payroll and estate taxes) and laws enacted since then as well. But that is not what is being discussed.
Our trade deficits do not result from bad deals but bad laws. Put simply, the amount of taxation and regulation that have been layered on our business owners and their employees have made it impossible for American firms to compete with foreign rivals. Contrary to the currently popular talking points, low wages are not the only means to establish successful trade balances. America became the dominant exporter in the world in the 19th and 20th centuries while our currency was strengthening, we were paying the highest wages, and our workers enjoyed the world’s highest living standards.
Germany is doing so today. Strong economies compete with quality, innovation, efficiency, and flexibility. Those capacities have been stifled by government policies that have nothing to do with trade agreements and have everything to do with domestic policies. We need to repeal those laws. Trade deficits are not the problem. They are the consequence of the problem. The problem is big government, financed largely by the income tax, which has made America uncompetitive.
But it is unlikely that tariffs alone, or even a broad-based national sales or value-added tax, could bring in all the revenue generated by the direct taxes we should eliminate. To survive on excise taxes, as the founding fathers envisioned, requires making the Federal Government a lot smaller.
But Trump is not promising to make government smaller. If anything, he is promising to make it even bigger. He has made no promises to cut government spending across the board, including popular “entitlements” like social security, which Trump has promised not to touch.
To make America great again, we need to recreate the free-market environment that made her great in the first place. It’s not just oppressive direct taxes that must go. It’s all the regulations that have driven up the cost of doing business, and labor laws that make employing workers so expensive and risky that business does all it can to create as few jobs as possible.
But contrary to Trump’s stump speeches, our trading partners are not taking advantage of us; we are taking advantage of them. They give us their products and we give them nothing but our debt. They expend scarce resources (land, labor and capital) to create consumer products for us to enjoy, while we just conjure intrinsically worthless dollars out of thin air. Years of excessive regulation and taxation have resulted in an accumulation of trade deficits that has transformed America from the world’s largest creditor to its largest debtor. Our once mighty savings financed a high-wage industrial economy that has been hollowed out, replaced by a weak, debt-financed, low-wage service sector economy.
Trump is right. This is a big problem and it needs big solutions. If tariffs were offered as a replacement to our ridiculous and destructive personal and corporate tax, and payroll and estate taxes, then America may become more competitive and our greater efficiency may even allow us to overcome the tariffs that other countries would likely impose on us in response. But slapping tariffs on imports, while doing nothing to improve the conditions for business efficiency, simply means that prices for American consumers will rise significantly, without sparking a revitalization of American manufacturing prowess. Don’t forget the global market contains over 7 billion consumers, the U.S. market just under 320 million. Insulating our manufacturers from this larger marketplace guarantees that we will never become globally competitive.
Tariffs or sales taxes will drive up the cost of goods for consumers, a fact that Trump seems to ignore. If he would acknowledge this issue, he could offer the counter argument that if we could couple tariffs with income tax relief that Americans would also have higher incomes to pay those higher prices. But even if incomes rise, higher prices will inevitably lead to less consumption and more savings, especially if we allow interest rates to be set by the free market rather than the Federal Reserve. More savings and less spending is exactly what we need if we want the capital to rebuild our industry. Protective tariffs alone will not work, especially when there is little industry left to protect.
So instead of criticizing Trump for his misguided advocacy of tariffs as a panacea, we should at least give him credit for recognizing a serious problem that so many others ignore. The real criticism should be directed at those who would allow America to continue down this self-destructive path.
Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube.