What is the True Cost of Tariffs?
Updated: Sep 21
EconBuff #54 with Rex Pjesky
Dr. Rex Pjesky talks with me about tariffs. Dr. Pjesky describes what tariffs are and how the incoming administration views them. Dr. Pjesky presents a number of potential uses of tariffs, including revenue generation, negotiation, addressing the trade deficit, as a tool towards achieving national security ends, protecting fledgling industries, and protecting intellectual property. We explore the revenue implications of tariffs on trade and their historical use as revenue generators. Dr. Pjesky argues that economists have not thoroughly researched the use of tariffs as negotiating toosl. Dr. Pjesky explains tariffs might lead to retaliatory tariffs and what that might mean for a trade war. We discuss the conventional wisdom on tariffs in the field of economics. Dr. Pjesky details how tariffs, and other taxes, should be evaluated in light of their impact on the width of the tax base. Finally, we consider the trade offs between an income tax and tariffs and we conclude with Dr. Pjesky’s view on the administration applying broad tariffs across the board next year.
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Transcript
EconBuff Podcast
LEE STITZEL: Hello, and welcome to the EconBuff Podcast. I'm your host, Lee Stitzel. With me today is Dr. Rex Pjesky. Rex is a professor of economics at West Texas A&M. Rex, welcome.
REX PJESKY: Good to be here again.
LEE STITZEL: Today our topic is tariffs, and of course it's in the news. It's the thing people are talking about for obvious reasons. I really want to dive into all of that, but let's start with the obvious thing: what even is a tariff?
REX PJESKY: Very simply, Lee, a tariff is a tax on a good that comes into your country from another country. So it's a tax on foreign imports.
LEE STITZEL: Is that a thing that the U.S. currently has some of? Is this a practice?
REX PJESKY: Well, we have some tariffs. We don't have a lot. I think that since the first Trump administration, we've had more than before that. Biden had some various tariffs and maintained a lot of the Trump tariffs as well. So I think over the last generation or so, the United States and the rest of the world have sort of been more pro-tariff than, say, maybe in the 1990s.
LEE STITZEL: The reason we're talking about this today is because the incoming administration is talking about tariffs so much. It kind of always has. It seems like maybe this last time around it's gotten even more focus. Maybe saying the administration is doubling down is too strong, but there is more focus on that. Why is the administration talking about tariffs, and how might they use them?
REX PJESKY: There are several reasons why governments have considered tariffs in the past. You would have tariffs to raise revenue. You would have tariffs for national security concerns. You would have tariffs as a negotiating tactic with other countries. You would have tariffs to address other political concerns that weren't strategic, such as protecting infant industries. You would have tariffs to correct trade deficits. You would have tariffs to try to enforce intellectual property concerns, and just a whole bunch of reasons politically why a government might enforce tariffs. As far as I remember, the Trump administration has basically talked about nearly all of those at one time or another.
LEE STITZEL: Yeah, I had sort of forgotten how many things they had brought up as potential reasons or motivations for doing that. So you said revenue generation. Obviously, anytime we're talking about a tax, which maybe I'm jumping ahead of myself there, that's going to be part of it. National security. A negotiating tactic, that's almost a novel one. When I think of it, that's my instinct, my default, that that's what Trump is going for. That probably wouldn't be what I would think of as a classic use, even by a politician rather than an economist. Protecting industries is a very interesting one. If I'm covering this kind of thing in class, the trade deficit is probably right where I'm going, because that's a topic where people are probably going to have the wrong instincts. But maybe when I see it in the context of this list of six or seven things, did I miss one? Intellectual property protection. Maybe I missed one. You probably missed several too.
REX PJESKY: Yeah, this is not an exhaustive list.
LEE STITZEL: So maybe walk us through briefly why the administration is, or how the administration means to use tariffs, on that list you just produced. They do talk about the revenue implications of putting on a tariff, for example.
REX PJESKY: Yeah. Trump and his policy advisers have been all over the place, almost to the point where I really can't pinpoint what his main goal might be. When you talk about any kind of policy, when you implement that policy, you really need to make sure your policy response is not random. You need to make sure your policy response is actually an answer to a policy question or a policy problem that you might have.
Basically, in no particular order, I think Trump has highlighted tariffs first to generate revenue. Trump wants tariffs to be revenue-generating to the point where he's even floated the idea of replacing the income tax with a revenue-generating tariff. He has spoken several times in the last couple of weeks that, and these are Trump's thoughts, not necessarily mine, the nation prospered and the coffers were full way back before we had an income tax. Before the income tax, the primary revenue stream into the federal government was tariffs. So we had a revenue tariff, basically. It wasn't a tariff designed for any other purpose.
The government back then wasn't necessarily trying to protect industries or intellectual property, even if such a thing really existed in the way we think about it now. It wasn't doing it for any kind of national security concern. The tariff was just a way that the government collected money in order to spend on its priorities.
A lot of commentators have been skeptical of this idea from the Trump administration because the volume of trade that we have is too small compared with what the government spends. Government spending every year is quite a bit more than even the total volume of trade that we have. So without massive restructuring of government and cuts in government spending, a revenue tariff that would replace the entire income tax and other revenue-generation mechanisms that the federal government has would be dubious, in my mind.
LEE STITZEL: I don't have these dates exactly in my mind, but pre-income tax is actually going to coincide mostly with an era where the federal government, the national-level government, did not operate in the way it does now. It didn't take in revenue and it didn't have expenditures, right? You're thinking about around 1914 and this kind of range, where the federal government didn't even really have a taxing arm. So you're comparing two very different eras there, so much so that if I were in some kind of discussion with the president, I wouldn't even want to have that discussion. It's like you're saying the country flourished the most when it was taking revenue in the form of tariffs and not income tax, but that's over a hundred years ago, when the federal government was a completely different entity from a revenue and spending aspect. Do I have that right?
REX PJESKY: Yeah. I don't object to that being brought up because, in a lot of people's minds, it might remind us that it's feasible because it's happened before. But again, the comparison of what the political process and the citizens of this country have come to expect from government now, compared to what they expected from government 120, 130, 140, 150 years ago, is completely different.
So if I were going to assign a probability of that actually happening, it would be very close to zero. But again, it is an interesting idea. The idea of a revenue-generating tariff just to be another income stream, another tax revenue stream coming into the federal government, is interesting to me. But I don't have any illusions that it could replace the income tax.
LEE STITZEL: Let's table the income tax thing because I do want to circle back around to that. You've got this interesting list here, and one thing that almost stands out as different from the others is national security. I think a listener might naturally ask: what do tariffs have to do with national security? Why would the administration think that's even possible, and how would you evaluate that?
REX PJESKY: This touches on, I think the word you used a few minutes ago was “novel.” This touches on a novel use of tariffs. I don't remember learning about this in my classes way back in the day, and this isn't something economists have really talked about. At least one economist, John Cochrane, whom I've read recently on this topic, has basically said that he is anti-tariff in almost any circumstance, but he said this reason for implementing a tariff is interesting to him. That's a big movement in thought for most economists.
It's using a tariff as sort of a sanctions mechanism. Instead of using sanctions like, “We're going to cut off your banking,” or “We're going to somehow blockade your importing or exporting,” or do things to stop or prevent trading with you, we're going to use tariffs or the threat of tariffs in order for you to bend to whatever the United States' will is.
LEE STITZEL: Okay, so is that a good idea or not?
REX PJESKY: I guess you wouldn't know until you saw the outcome, right? Just like sanctions. If the United States were able to use those tools to achieve national policy goals, that would be good to the extent that the national policy goals were good.
LEE STITZEL: Yeah, it's hard to evaluate. As economists, I think our instinct is, “I don't really want you setting economic policy to try to achieve national security ends.” Anybody who's not a professional economist is going to look at that and say, “Why not? These things are inextricably linked. Why would I want to break them apart?” So maybe my academic, professional economist instincts aren't good in that respect. Maybe Trump and the administration have something more there, and guys like you and me, although I shouldn't lump you in automatically with me on that, maybe we should step back and learn something there.
REX PJESKY: I think that's an interesting thing you've said. Up until maybe six months ago or so, I didn't do this during the first Trump administration or since then, but about six months ago I started to read and listen to some commentators talk about tariffs who were not economists. It was really eye-opening to me, a different perspective on these things. I think your point is an extremely good one. An economist might reflexively reject tariffs as a tool for negotiation at all, but as you say, anybody who's not an economist would say, “Well, why not?” It's just another tool, perhaps, in the negotiating arsenal that we have. Why not use it? Trump seems to really think tariffs might be a powerful negotiating tool for the country and his administration.
LEE STITZEL: The negotiating aspect, because Trump wants to brand himself that way, is probably the most interesting of all the reasons we've listed here and are about to work through. I remember in his first administration having discussions with smart people who were not professional economists, and they were saying, “What Trump is going to do is use the potential for a tariff to leverage better terms of trade,” maybe an imprecise use of that phrase, which you can discuss a little bit, “and get us a better deal.” That's the art of the deal. That's Trump's whole thing. He's not a statesman, he's a businessman. That's what he's going for.
So I'd like you to do two things. Maybe talk about that a little bit, as you see it as a tool, and evaluate how that might or might not work. Then second of all, can you put aside the economist's conventional wisdom and disdain for tariffs if what that achieves is more free trade by threatening tariffs that you eventually negotiate back toward fewer tariffs?
REX PJESKY: Yeah. If I were advising the Trump administration on tariffs or trade policy, I would advise him, first, to make sure that he is very clear on what he is trying to accomplish with each individual tariff policy. I would remind him that a tariff is like any other tax or any other policy. The devil is in the details. There are good and bad ways of implementing any policy, and regardless of your policy goals, there are good and bad ways to achieve it. You might have great policy goals, but if you pursue those goals with very poorly designed and implemented policies, it's not going to be good.
I would remind, or sort of plead with, the Trump administration that somewhere in all of the negotiations being had with other countries should be the message that complete free trade is on the table. If you take your tariffs off, if you take away your policies that are interfering with U.S. companies' ability to do commerce with you, then we will absolutely do the same.
So use tariffs as a negotiation tactic, not only for national security concerns but also for pure economic concerns, where a regime of free trade is understood to be the best policy. But if other countries aren't doing that, then the United States is no longer going to have the policy that we're going to unilaterally pursue free trade with you either. I would put free trade on the table.
If the Trump administration would keep those three pieces of advice that an economist would give him, then again, as an economist, I would leave everything else up to the political process. Keep those things in mind, do your thing as a politician, and then everything will be great.
LEE STITZEL: Suppose I wanted to make the most charitable case. It's not clear to me that Trump wants tariffs for the sake of tariffs. He views them as a tool toward political and economic ends. In that case, of course, you can leverage those things in different ways, in ways that a textbook might not cover because a textbook is going to say, “A tariff is a revenue-generating tool. The end.” That's an uncharitable description of a textbook, but for simplicity's sake let's go with that.
How would you react to that case? Would you say Trump wants tariffs for the sake of tariffs, or are these just negotiating tools? If he managed to use tariffs over the next four years in such a pattern that he got more free trade, better national security, protected the industries he wanted to protect, et cetera, but we ended up on net with much less tariff activity at the end, he'd be happy. Would you think that's fair or not?
REX PJESKY: Yeah, absolutely. Again, if you're taking the most charitable view possible, I think that might be the whole idea. At least, I hope it is. I hope it's the whole idea.
The Trump administration seems to want, and I'll use his words, other countries to not “rip us off” in trade. He's said that many times. If he can use the threat of tariffs to stop that, whatever he means by that, I think that would be fantastic, again assuming he's right. He also wants our companies, by “our companies” I mean companies in the United States, to be able to trade with anybody in the world basically using the same rules that everybody else uses.
LEE STITZEL: This is where an economist is probably going to jump in and say that there's no “ripping us off.” This is mutually beneficial exchange. If you're making a trade, it's a good thing. Maybe you're not getting the best possible deal, et cetera. Is that the kind of argument you would make here as well, or do you see room for what the Trump administration might argue in that vein?
REX PJESKY: Trump might agree with that as well, right? All trades that are voluntary are mutually beneficial. That's by definition. That's true based on how we define those words. But that doesn't mean you can't get a better deal. I might be willing to pay $30 for something, but if I could pay $28 for that same thing, that's better. The trade still goes on. My trading partner might be willing to accept $20. So what the Trump administration might intend to do, and this would be the “ripping off” thing, is to push that number that U.S. consumers pay down.
LEE STITZEL: So you mean mutually beneficial exchange is true, but only in a trivial way? That's just a fundamental truth. If you and I agree to make some kind of trade and we're not coerced, you're not robbing me, then by definition I must be thinking I'm getting more from you than what I'm giving to you, and vice versa, or at least as much. Do you mean something else by saying “in the way that we define those words”? Does that mean something broader in this context, or no?
REX PJESKY: No.
LEE STITZEL: Okay, so that's the exact use you're going for. In that case, this applies to any level of trade. It applies to two kids sitting in the lunchroom. It applies to my relationship with the Walmart down the street. Economists would jump on us if we said “U.S. trade with China,” because nations don't trade with each other. Individuals and entities that belong to those two countries might trade with each other. Therefore, we're thinking this must be some kind of fundamentally good deal.
I think that's a good segue into what the conventional wisdom on tariffs would be from economists. Could you just lay out how economists would think about tariffs conventionally?
REX PJESKY: Very simply, the conventional wisdom among almost all economists would be that tariffs are not good. You don't want to interfere with international trade flows using taxes. The reason they would say that is the same reason they would say that any kind of market intervention is bad.
If you put a tariff between the flow of goods between two nations, that interferes with the application of what economists call comparative advantage. Some nations might be relatively better at producing certain things than others. A tax on trade between those two nations would interfere with that, and so that makes resource allocation less efficient and it's going to make people in both nations basically poorer.
LEE STITZEL: I wanted to set that up because one of the next couple of things on our list to talk about here is protecting industries and addressing the trade deficit. Given we've set up a view where Trump is saying these are the potential things we could use tariffs for, not that he wants tariffs for the sake of tariffs, but he's looking for policy ends, political and economic outcomes, and the conventional wisdom is mutually beneficial exchange, access to trading partners, being able to take advantage of economies of scale, and probably most importantly comparative advantage, which has to be facilitated by trade, where does protecting different industries or dealing with the trade deficit fit into that?
REX PJESKY: I think they're separate issues. There seems to be less talk about the trade deficit recently than there has been, especially in Trump's first administration. As an economist, I think that's a good thing because it's not clear to me that we should be worried about the trade deficit. Secondly, if we are worried about the trade deficit, it's not clear to me that tariffs would fix that. Tariffs are probably terrible tools to use if you want to actually fix the trade deficit.
I think it's going to have basically a random impact, if any, on the trade deficit. If we increase tariffs, I wouldn't make any predictions at all about what would happen to the trade deficit. The trade deficit could go up. The trade deficit could go down. The trade deficit just represents a difference in flows. Tariffs are going to make overall flows lower, so it's not clear to me that that would make the difference in two flows that are both going down lower or higher.
LEE STITZEL: The trade deficit is the relative size of those two things. In an intro to macro class, which I teach all the time, I have basically a whole lecture dedicated to trade in which I make the case that because of mutually beneficial exchange, what we care about is total trade volume altogether. Whether we're in a trade deficit or capital surplus, we don't really care very much. Given what you just said, would you be critical of that in this context?
REX PJESKY: No, not at all. Ultimately, in traditional economics, we measure how much trade there is. The source of that trade doesn't really make any difference. When you're learning economics as a first pass, you buy things based on how much they benefit and cost you. Where those things come from is not even a secondary concern for you. It's not a concern for you at all.
If you buy a shirt or a car or something like that, and that's the best shirt or car for you to buy, it doesn't make any difference whether that stuff is produced in Alabama or Albania. That's irrelevant to you. You will buy the best shirts, the best cars, the best whatever you can, based on what those things cost and based on your own preferences.
When you take principles of economics, that is sort of the end of the story. More advanced economics looks at those things in a little more nuanced ways. The political process certainly looks at those things in a more nuanced way. The political process is extremely concerned about where things are produced. It's something politicians talk about all the time. Regardless of whether you're at the municipal level, county level, state level, or national level, politicians all the time, and the reason they do this is because citizens react to this, are talking about job opportunities for their citizens. “We're going to produce shirts here. We're going to produce cars here.” There's a big difference between what economics teaches and what the reality of the political process is.
LEE STITZEL: So that leaves room for the observation that I think people would say they do care where stuff comes from. Probably in practice they don't seem to care as much as they say, because when they're actually making choices they're revealing their preferences toward choosing whatever product is best for them based on the combination of price, quality, the attributes of the good, and so on.
In addition, it's just hard. It's easy to put something on a tag, “Made in USA,” “Made in China,” or whatnot. Most things are made up of components and have different inputs and combinations of inputs that were manufactured elsewhere in that process. So it's not even clear that it makes sense to say where most things are made. But what would you say to that? Because our listener is going to say, “But I do care whether it's made in Alabama or Albania.” What would an economist answer to that?
REX PJESKY: Again, it goes back to your revealed preference. Sometimes, and I'm not saying this characterizes every transaction, it's really cheap talk. We say, “Wow, we want goods that are produced in the United States,” but when we really go out and buy things, we don't care. And it's not like anyone goes out and specifically looks to buy the imported good either, at least not in the context that we're talking about.
LEE STITZEL: Let's be fair. There probably is some element of your choice that is, “Where is it made?” We could argue about what size that is. It's almost certain not to be the deciding factor.
REX PJESKY: Yeah. If two goods were identical and one of them was made in the United States and one of them was made anywhere else, I think an overwhelming majority, probably approaching 100 percent of people, would probably buy the one that said “Made in the USA.” So there is some preference that consumers have for that. That's perfectly reasonable for me to think. But how much exactly is that worth?
We are obviously very enthusiastic about buying things that are made other places, because a lot of the things on the margin that we do buy are made other places. Probably every article of clothing I have on right now was made somewhere that's not in the United States.
On the other hand, the actual trade volume that the United States has is pretty small. What is it, like 12 to 15 percent or so of the things we buy are made in other countries? I think most people would guess higher than that. But again, that's not surprising because a lot of the really big things that we buy, our houses, our health care, and a lot of times our cars, are domestic. Even if it's your Honda, it might be made in the United States. A lot of cars that have Japanese or other countries' nameplates on them are actually made here. So the amount of trade that we actually have in the United States with other nations is probably smaller than most people would guess.
LEE STITZEL: I'm kind of glad that the trade deficit discussion is not very prominent right now, because I think as an economist a lesson I would want to impart is: don't care about the trade deficit. That's what you should do, not care about it and care about these other things. Which means if the administration is not talking about the trade deficit but is talking about other reasons they might want to levy tariffs and other things about the nature of trade between countries, I'm pretty happy with that because we're on to more substantive things.
You've done a great job listing what things we might do to apply to the tariff. We could sit here and talk all day if we got too far afield about all the different ways that we might care about manipulating trade policy to the U.S.'s favor. But I do have some kind of soft spot for somebody who says, “I want to buy local.” I do care about people. If I'm engaged in mutually beneficial exchange, both parties are benefiting, and I can make the other side of that trade somebody local to me, or somebody who's a fellow countryman, or has whatever characteristic I might share with them, perhaps they're of the same faith or something like that, more power to you, right? If that goes into the calculations, that's an individual choice and probably shouldn't be done at a policy level.
Now, maybe you push back on that, and probably lots of our listeners would say, “No, I would like policy choices to be made that would enrich our countrymen, and I don't really care what the ramifications are for people outside this country.” Do you have a comment on that?
REX PJESKY: If who made something, where it was made, and how it was made is a preference that a consumer has, one of the lessons in principles of economics is that economists don't judge other people's preferences. If that is a characteristic of a good that is important to you, then economics has nothing to dispute about that. It actually ends up being a political question at that point.
If individual consumers want to buy goods based on all of the dimensions that you said, economists aren't supposed to judge that. Those things might not be important to me.
LEE STITZEL: It's not crazy, though, right?
REX PJESKY: No, of course not. If my brother-in-law starts his own company and starts producing beer, of course I'm going to go there and give him my business. It's not that much crazier to open that up to a wider application of, “Who is my kin? Who's my family?” I don't find that crazy at all, which is part of what makes me happy that the trade deficit conversation is just not a very big component of what's going on right now.
LEE STITZEL: Well, I'd buy from my relative if it was good.
REX PJESKY: Yeah. No, that's actually a great point. I said, okay, I'd like to give my business to my brother-in-law. Depending on how close you were, the closer you were to me, the more I would overlook quality, but only up to a point. If my brother-in-law's beer is undrinkable, forget it. There's only so far that I'll go. All the better if his beer is the best, right? If that's the beer I like best in the world.
LEE STITZEL: I don't want to get off the rails too much, but would you expect your relatives to send their kids to WT because you work here?
REX PJESKY: Yeah, not at all. Zero.
LEE STITZEL: So that's a topic for another show, perhaps. No, you've highlighted what may be the error in my example, which is that's only true if you have some particular type of ownership over the final product. These decisions, and I think the illustration of your brother-in-law's beer and our fine university, which everyone who's looking to go to school should come here, I recommend that, a plug for us, and our different attitudes in those different contexts illustrate the complexity of people's thinking on things all the way up to international trade. They don't make sense, and the tools of economics would have a very difficult time making sense of them.
REX PJESKY: I don't think it's that they don't make sense. I think it's so complex. There are so many moving parts. It probably doesn't even make sense to ask what is the relative importance of any particular attribute of what it is you're choosing to produce and consume, because there are probably interactions among those things that are really difficult to disentangle. Add on top of that that at any level beyond your individual choice, you're having to aggregate a bunch of people's choices into a market. Once you aggregate them, maybe it's not even possible to analyze.
LEE STITZEL: All right, I'll grant your point completely that these things do make sense based on the fact that I can predict that you would be favorable to buying your relative's beer, but you would not expect anyone to attend the university where you work. Because I could predict that so easily, then they must make sense.
So those two situations that I tried to make seem the same must be different, even though in some context they are the same. You're producing education services for people. Somebody else is producing beer for people. But who we buy from being important is different in those two circumstances. Again, economists probably could at least give reasons why. It might be hard to model, but intuitively I think we know these things. This is the complexity of trade.
And this is why, again, I think one thing that all economists would celebrate, assuming we're right here, is the talk of trade deficits being virtually nonexistent in at least the last month. That's actually a good thing, because trade policy probably doesn't have very much to do with the trade deficit. Again, that's strange, but it's probably true.
REX PJESKY: The trade deficit has more to do with government deficits and capital flows than it does with the terms of trade in consumer goods.
LEE STITZEL: Yeah. So it's interesting, because I think one reaction might be, “I would care about giving business to somebody who's more local to me, and as a consequence I might factor that in.” But they might acknowledge, yes, when it comes down to quality, price, all the things that we ought to be competing on in a market, those things are going to be a big factor.
But it does change if you're going from, “Here's a competitor and we're on this margin of success,” compared to trying to protect an industry that might completely go away from the United States. Do you leave any room for that, for protecting these different industries? I think when you first brought this up you mentioned infant industries. Of course, I think a lot of people advocating for this kind of protectionist instinct are going to argue for any industry in the United States.
REX PJESKY: I think economists mainly talk about infant industries, but whatever you come up with to protect a new industry theoretically could protect any industry. The car industry or the steel industry in the United States are not new things, so they wouldn't be infant industries. But you could design a tariff, which may or may not be successful, specifically to address the continued existence of, say, the steel industry in the United States.
If the political process thought that having a steel industry in the United States was important for any reason, then again, that might be something that might be good politics even if it's not necessarily good economics.
LEE STITZEL: So would you leave any room for using that kind of tariff in that kind of way?
REX PJESKY: There might be. It would depend on the design of the tariff.
LEE STITZEL: Sure. Devil's in the details, as you said.
REX PJESKY: Yes. You can't just say, “A steel tariff will protect our steel industry.” It might not. You might lose other industries because of a steel tariff too, because producing steel, for instance, isn't an end in itself. Other things also use steel. If you had an industry that made things in the United States that used steel, a steel tariff might be devastating to those industries.
So the devil would be in the details. It would have to be designed properly to even have a hope of succeeding at your ends. Anybody understands this: it's the right tool for the right job. If I'm trying to take apart something that's bolted together and I ask you how to do it, and you just say, “Use a wrench,” that isn't enough. If it's bolted together with 9/16-inch bolts, then I'd have to use that size wrench. If I used a wrench that wasn't that size, it's not going to work at all. That's a decent analogy for what we're talking about.
LEE STITZEL: There are two directions I'm torn between going here. On one hand, I want to talk about the seen and the unseen, the diffuse and the concentrated, so maybe I'll come back to that in a second. But what I think a listener would say is, “Right, but look at what's happening in the global market for many of these U.S. industries. They're facing unfair competition practices where industry participants in other countries are being benefited in a great many ways.” Some of those would just be trade-protectionist policy in those countries, and some of those might be things we would consider immoral, certainly things that would be criminal or illegal here but are not in other places in the world. Do you have some sympathy for that kind of argument in this context?
REX PJESKY: Maybe. Not everybody has to play by the same rules in order for trade to be okay, in my mind. I think economics would generally agree with that kind of statement. Just because some other country has slightly different worker-protection rules than we do, it doesn't necessarily mean that our companies in the United States that have to comply with those kinds of things are at a disadvantage, or at least at a disadvantage that we should care about in terms of policy. That wouldn't necessarily, in and of itself, be a reason for us to shut off trade with those individuals completely.
Maybe a tariff could correct that. Maybe if somebody calculated that the rules your companies play under in your country put you at a 5 percent advantage compared to a similar company in the United States, we're going to put a 5 percent tariff on you. Maybe you could come up with something like that and fix it. But I don't think a discrepancy in rules is, in and of itself, evidence of an unlevel playing field.
LEE STITZEL: Yeah, that's almost exactly where I was going to go. What if you had some kind of labor laws that we wouldn't allow here, and then somebody said, “Let's use a tariff to directly correct that”? You have a hard enough time understanding a regulatory environment in the United States, let alone calculating the implications of somebody else's regulatory state and its complexities, and therefore backing out what kind of competitive advantage that confers on them. So it's probably tilting at windmills, even if it were theoretically feasible.
Let's go back the other route, then. The classic textbook response about protecting industries will be: you protect an industry that can't compete on the global market and you're tying up resources in that, because that's seen and that's concentrated. But if you allow competition to do its thing, then everybody benefits, and as a consequence those resources and those individuals are going to be freed up to do other things at which they will be relatively better.
Most people who have not bought into the belief system, as far as economics goes, that you and I have are probably not going to find that very satisfying. What would you say to them?
REX PJESKY: A response to that, perhaps, might be that those kinds of situations aren't unique to trade policy. Tariffs in general are just taxes. It's interesting to me that economists have a particular disdain for tariffs themselves, more so than other taxes. There are reasons for that that I know and understand. But this concentrated-benefits-and-diffused-costs problem, and interfering with efficient resource allocation and stuff like that, a government's trade policy is just a tiny sliver of what it does along those lines.
Governments do things that make resource allocation inefficient on some margins all the time. According to some people, it's what governments do. The reason we have governments is to basically interfere with some kinds of trade. There are lots of things that the government taxes differently and treats differently, and we don't scream “resource misallocation” in those situations.
An example of this might be excise taxes on things like tobacco products. We've judged tobacco products to be bad for you, so we're going to levy an extra tax on those to discourage their use. That misallocates resources in the same way there is a misallocation of resources if the government would say, for instance, “Foreign imports are bad for us, so we're going to levy a special tax on them,” and that causes an inefficient resource allocation. It interferes with comparative advantage, the whole thing.
Ten years ago, I wouldn't have thought this way at all. But now that I've been exploring, and because tariffs and international trade have been at the forefront of everybody's mind, I've started thinking about these things in those kinds of ways. I grew up as an economist, and a little bit less so for you because you're younger than me, but I was trained as an economist and started my career as an economist during probably what could be considered the absolute heyday of free trade.
Most of the history of humanity has not had that attitude about trade. It's this unique 20-year period in our history, from say 1995 to perhaps 2015, where everything was free trade. Since then, people are saying, “Wait a minute. Maybe for whatever reason, national security, unfairness, all of those reasons you might put tariffs on in the first place, maybe international trade is bad for those particular reasons and maybe we should slap a tax on it.” That would be heresy among economists, and I understand that, but why the discrepancy? It's just interesting to me.
LEE STITZEL: John Cochrane has a piece on tariffs which didn't directly motivate this podcast, but was informative to me when it came out. He says something very similar to what you just said, that economists generally don't like this. I'll read a quick quote from him: “I'm not a fan of tariffs, but not a catastrophist either. There are so many regulations and taxes raising costs and distorting prices by 20% in the U.S., one more won't crater the economy. If they are counterproductive, as most economists believe, we'll find out soon enough.”
There are multiple elements there. You said most economists are not fans of tariffs. What's one more price distortion? And we might get a chance to find out how good our free-trade theory in the field of economics has been all along.
What I'd like to do, then, is maybe have a discussion that I don't see a lot of economists having, which is to talk about the different taxes and their relative efficacy, their relative efficiency, and some of that. One of the things I realized in all this discussion, when admittedly for the reasons you said earlier it's almost silly to say, “Let's replace the income tax with a tariff,” because sheer trade volume probably makes that not very feasible, is that it begs the question: how do we think about the efficiency, the negative impact it might have on the economy, of levying different taxes? So maybe just kick us off talking about income taxes and tariffs.
REX PJESKY: That's a really good point, and it's something I hadn't thought about until maybe six months ago. I don't like tariffs. I'd like for them to be zero. On some level, I think there would be a lot of reasons to have zero tariffs. But I don't like other taxes necessarily either.
LEE STITZEL: Is that because you would favor no taxation?
REX PJESKY: Well, no, because you have to have a government. You have to have some way for the government to collect revenue.
LEE STITZEL: You're not arguing from anarchy.
REX PJESKY: No, absolutely not. I'm trying to convince myself: why wasn't I an anarchist because I wanted tariffs to be zero but I didn't want other taxes to be zero? There has to be a reason why I thought that. Again, it's something that five years ago I hadn't thought of really at all.
I think tariffs are bad, but I have to have an explanation of why they are uniquely bad. Why, dollar for dollar, would I think that revenue generated by a tariff was worse than revenue generated from a corporate income tax, or a personal income tax, or a payroll tax, or user fees, or consumption taxes of various kinds, or a value-added tax like they have in Europe, or an inheritance tax, all of these other taxes?
I'm not saying there aren't answers to this question. I think one reason why a tariff might not be preferred as a means of taxation is because the base is narrow. Generally the theory of taxation says that, regardless of other considerations, you want your tax base to be as broad as possible. If we're going to uniquely tax foreign-made goods, that's a narrower base than taxing all goods.
LEE STITZEL: By that, do you mean that the number of people who are going to be affected in the U.S. is fewer than the number of people who are going to be affected by an income tax in the U.S.?
REX PJESKY: When we talk about the tax base, it's this. Let's say you want to raise a trillion dollars in revenue. You want the rate of taxation needed to generate that revenue, whether it's a trillion or a billion or anything, to be as low as possible on the activity you're taxing.
So if you think of a tariff as a tax on foreign goods, and not all economists think of it that way, I'm just using it for illustrative purposes, and 10 percent of what you buy is foreign goods, and you compare that to a general consumption tax, if you're going to raise the same amount of revenue your tariff would have to be ten times higher than your general consumption tax on everything, including foreign-made goods. If your trade volume was half of your consumption, then your tariff to raise your trillion dollars would have to be double the rate of your general consumption tax, if that's what you're going to tax.
The question becomes: what is the better tax system? Of all the choices of taxes that we can levy, what's the most efficient? Are tariffs even more efficient than others? A lot of politicians right now don't want to raise tariffs, but they do want to raise corporate income taxes, for instance. It's very difficult for me to choose between those two. I've got a pretty good idea that one of them might be better than the other, but I'm not sure.
I start thinking about what, other than the size of the base, might sway me to think one is worse than the other. With the corporate income tax, there's quite a bit of evidence that it might interfere directly with capital formation, which in the long term will cause wages to be lower. That's really bad. Most economists think corporate income taxation is particularly bad for that reason.
With tariffs, the biggest thing that's unique about tariffs is the threat of retaliation. You levy a tariff against another country's goods, and the government in that country might slap a tariff on your exports to them, which would be imports for them. That multiplies the damaging effect of the tax because you have retaliation that creates more distortions, more deadweight loss, and more interference with people's ability to make beneficial trades.
I don't know how to weigh those two against one another, but if I were going to make a case in today's political climate for tariffs being a particularly bad way of raising revenue, that would be what would cause me to pause. National security concerns and things like that are a whole different discussion. If we're talking about tariffs as a mechanism to raise revenue, first you have the threat of retaliation, which might be uniquely bad, and second you have the fact that the tariff is necessarily going to be a narrower base than other taxes you could choose.
The things that wouldn't help me decide among taxes are the kinds of things a lot of people are saying today, like, “If you slap tariffs on things, it will raise the prices of things.” Well, any tax does that. Corporate income taxation will directly raise the prices of things subject to the corporate income tax and also lower the wages of workers. There's a whole literature on how those burdens are divvied up.
If you increase a tax by a dollar, that money has to come from somewhere. It comes from shareholders, consumers, workers. A tariff is the same way. That money has to come from somewhere. Both things result in lower trade volume in one way or another. Those are the things all taxes have in common, including tariffs. How are tariffs different? That's how I would decide among those different mechanisms.
LEE STITZEL: So if I actually tried to swap out an income tax for a full tariff system, a proponent of that is going to say something like, “Well, Americans won't pay taxes. People in other countries will pay. What a great deal for Americans.” And you just said the price thing is a nonfactor because a different tax structure is going to have some kind of implication for prices no matter what. What would be your rejoinder to that?
REX PJESKY: Well, again, that's just not a factor.
LEE STITZEL: Sorry, not the prices part. Just if we tried to make the argument that Americans wouldn't pay this tax, other people in other countries would.
REX PJESKY: Yes. The legal incidence of the tariff is ultimately going to fall on American consumers, or I guess the legal incidence is going to fall on whoever is doing the importing. There's going to be a certain point where the United States government is going to identify a certain good as an import and say, “You've got to remit this much money because of the presence of this trade that you're making.” That's true with sales taxes and everything else.
So in that sense, a tariff would operate just like a sales tax. There's going to be some point where somebody has to remit the money. That individual is most likely going to be a U.S. citizen, and just like with a sales tax, whatever that amount is, I'm going to say that all of that is going to be passed on, just like a sales tax is passed on, to whoever buys the good. The import duty or whatever will be tacked on in some way. It could be seen, it could be unseen. Economists don't care about that. It's going to be paid for.
Now, some of the economic incidence is going to fall on the foreign company, but I don't think that's necessarily a good thing. What effect is the U.S. tariff going to have on a foreign producer? The ultimate end price of whatever they're selling is going to go up. That means the scale of their business is going to go down, so their profits are going to be less. That's how they bear the burden.
I don't see that as a benefit to us at all, because that's just fewer goods for us to consume. So yes, just like with any other tax, the economic burden of that tax is going to fall on the ultimate buyer and the ultimate seller, and of course everybody in between. But the fact that the seller might bear some burden is no consolation to anybody in the process.
LEE STITZEL: So the seller loses some. No one gains because of that?
REX PJESKY: No one gains because of that at all.
LEE STITZEL: If that's true, that's going to be key, because I think there's going to be a contingent of people who are going to say, “No, no, we can get other people to pay our taxes.” And you're saying that's not how that works at all.
REX PJESKY: No, that's not true. You can't. The political process, as an act of will, cannot alter the economic burden of a tax. It cannot. I believe in that dogmatically. That's like I believe in gravity. You cannot show me something that's not subject to that. That would be supernatural at that point.
LEE STITZEL: Let me flip it around and take it from the other side. Suppose I think tariffs are the worst. I think this is a terrible policy choice from the incoming administration if this is the route they go down. And I paint this picture for you. I say, “Look, you're going to put these tariffs on, and people are going to stop trading with the U.S. They're going to engage in a trade war. They're going to do all these things, and global international trade is going to collapse, maybe even, and the U.S. will be impoverished by this.”
To the extent that the administration is levying potentially large tariffs, not completely swapping out an income tax for a tariff system, not that, but just the 25 percent tariffs the Trump administration talks about a lot, what would you say to somebody who's that ardently against tariffs?
REX PJESKY: I would agree with the statement that you just read from Cochrane. I just don't think so. It could be another really poor policy choice. It's very easily reversible. If it ends up being bad, it can be reversed very quickly. Tariffs can be put on very quickly. They can be taken off very quickly.
So if the Trump administration is clever, whenever they implement these policies they'll be monitoring their efficiency, and if the tariffs are not having the desired effect, then I would hope that a political administration that wants to be popular would reverse them.
LEE STITZEL: What about the idea of retaliatory tariffs, the U.S. losing a trade war kind of scenario? Do you put any stock in that or those kinds of things?
REX PJESKY: That's really quite interesting. The devil would be in the details with those too. I don't want to say retaliation wouldn't be bad. Retaliation would be bad. I don't want anyone to say that anyone absolutely wins a trade war. That's true, and I would say that dogmatically.
I don't even want to claim that it would be a good thing for the United States to even relatively win a trade war. If we can have trade policies that hurt us a little and hurt other countries a lot, that's not good either. That's still no one winning.
LEE STITZEL: That comes to a core idea in economics. We inform a lot of our decision-making in zero-sum environments, and economics just isn't like that. Things can benefit me and benefit you. We can both come out ahead. We can grow the size of the pie, the whole thing. So yeah, I do think that's a good thing to keep in mind.
We're coming up on an hour here, and I appreciate your time. I want to finish off the podcast and talk about tariffs in the context of inflation and an inflationary environment.
The first thing I'd like to ask is this: I think some people think of tariffs as, you're going to put this tariff on and prices are going to keep going up and up and up, much like we would talk about inflation. Sometimes the way people discuss inflation can be a little confusing, but there's a pattern to inflation that if it gets away, that becomes the new equilibrium. You have to go out of your way to stop prices from going up. So talk about tariffs in that way, comparing them to inflation.
REX PJESKY: I think the discussion of tariffs and the discussion of inflation are completely unrelated, 100 percent unrelated. If tariffs are a good idea when inflation is 2 percent, then tariffs would be a good idea if inflation is 5 percent, and vice versa. If tariffs are a bad idea at 5 percent, they're a bad idea at 2 percent too.
Tariffs are not inflationary. Tariffs do increase the price of goods that are subject to the tariff. Those two statements are not contradictory.
LEE STITZEL: You can see people thinking: inflation, prices; tariffs, prices. Yep, it's the same thing.
REX PJESKY: To anyone who hasn't studied economics pretty extensively, that would be a puzzle to them. But tariffs, you can think of tariffs as one-time increases in the price of goods that are subject to the tariff. The price of the good that's subject to the tariff is low. After the tariff, the price goes up according to supply-and-demand conditions in that good and the size of the tariff.
Amazingly enough, that is not what economists think of when they think of inflation. Inflation is the persistent and continuous erosion of the value of a single piece of currency in the economy. Inflation is caused by there being more currency relative to the number of goods that are around, and tariffs are these one-time shocks. Tariffs are a micro phenomenon. Inflation is a macro phenomenon. In this case, the two don't have anything to do with one another.
So the discussion about tariffs combined with inflation should be a nonstarter, either politically or in economic circles.
LEE STITZEL: To bring us in for a landing, how would you view the administration broadly applying tariffs over, say, the next year?
REX PJESKY: I think the chances of them doing it are pretty high, and they're going to happen. It will be very interesting as an economist to see the impacts of that happening.
Again, to circle back to the beginning of the discussion, within the universe of possible tariffs there are smarter ways to implement tariffs than others. Not all tariffs are equal. The devil is going to be in the details. If you want to raise a billion dollars with income taxes, there are better income taxes than others to do that. Tariffs are exactly the same.
LEE STITZEL: My guest today has been Rex Pjesky. Rex, thanks for joining us on the EconBuff.
REX PJESKY: Thanks for having me.
LEE STITZEL: Thank you for listening to this episode of the EconBuff, where we find applications of economic thought in a variety of topics and fields. If you enjoyed today's discussion, be sure to check out our previous episodes on YouTube, Spotify, and Amazon Podcasts under the title EconBuff Podcast, and be sure to like and subscribe for updates and information.
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