Tariffs Part I: The American Experience
Tariffs have been in the news quite a bit. No matter when that was written, it would be true. Tariffs, a tax on imported goods, have been integral to many significant events in history.
The Founding of the Colonies
The prevailing economic system in the 14th -18th centuries in Europe was Mercantilism, a political-economic system that argues national prestige comes primarily from accumulated wealth. Mercantilists believed wealth was money (precious metals in those days) and a country needed to increase monetary inflow and decrease its outflow. Achieving this goal required export encouragement (subsidies) and import discouragement (tariffs). England, France, Spain, and others followed this approach. However, logically, if every country is Mercantilist, it will fail. For a country to export, someone has to import. So there was a need to create captive markets, places that had to import because the exporting country controlled them: colonies.
The mother country established trade, monetary and tax policy for their colonies. This is why Americans used things like tobacco for money; England did not allow America much hard currency.
The American Revolution
In the 1770s, the British government found itself in a hard political situation. The Americans were getting rowdy and had already been costly with the French and Indian War, which in reality was a world war fought on six continents, and any taxes imposed on the Americans (i.e. Stamp, Sugar, and Townsend Acts) to pay for war costs (more than 50% of the British government’s budget during these years) were met with strong political resistance and rampant smuggling. Jefferson made America’s frustration very clear when he included restricted trade among the list of reasons enshrined in the Declaration of Independence.[1]
Meanwhile, on the other side of the world, the most prominent non-government symbol of British power, The East India Company, was in financial trouble… again. Deemed too big to fail (it was huge with its own 70,000-man army), the British government bailed out the Company by passing the Tea Act, which granted them a monopoly on the tea trade in America and imposed a tax on tea, forcing Americans to pay for Company management blunders. One rebel group responded by raiding the East India ships moored in Boston harbor and throwing 342 crates of tea overboard. Most of the taxes referred to in the slogan “no taxation without representation” were tariffs.
The American Tax Structure
Despite the experience with Britain, when the American Colonies became the United States of America, its chief financial officer, Alexander Hamilton, won the policy debate to impose tariffs, arguing that young American industry needed to be protected from older European merchants. This was formalized as policy after Hamilton’s 1791 Report of Manufactures, as“virtually every tariff recommendation was adopted by Congress in early 1792.”[2] While there was broad support for the policy, it laid the groundwork for north-south division; the industrial north wanted high tariffs, while the agrarian south, reliant on exports of basic commodities, needed freer trade. Tariff policy, along with other issues, came to a breaking point in the 1860’s.
The Civil War
The American Civil War was fought over slavery. But there were other reasons. Most Southerners were not slave owners, never had been and never would be, but there were policies that actually impacted many more white Southerners than slavery: One was tariffs. It was a secondary cause, at best, but not unimportant.
After Hamilton, Senator Henry Clay often led the tariff debate. From 1806-1852 Clay, along with Senators Webster and Calhoun, dominated American politics, and the tariff was a big issue with significant tariff legislation enacted in 1824, 1828 (the largest in U.S. history and called the Tariff of Abominations), 1833, and 1842. There was another tariff in 1857, after all three Senators had passed away, two while in office, and then that tariff was increased by the Morrill Act of 1861 which probably only passed because seven southern states had already seceded and Congressional opposition was almost gone. Even though Clay was 10 years dead, it was his vision, and it was effectively U.S. trade policy until 1913. Clay wanted tariffs to keep European trade out of the U.S and for the federal government to build an infrastructure to develop the West and replace trans-Atlantic trade with North American trade. For the South, still reliant on trade with Europe, this was one more reason to secede. Losing the War — and political clout for the next 50 years — kept the policy in place.
1913
In 1913, the federal income tax was enacted. This effort was led by Southern politicians and was a remarkable political feat. The South, which had been in retreat since Gettysburg, managed to push through an income tax that disproportionately fell on Northern taxpayers, while simultaneously reducing (almost eliminating) tariffs which benefitted Southern taxpayers.
However, this political coalition was fragile, and World War I and the post-war elections led to a resurgence of the tariff advocates. In the 1920s, America ended up with both tariffs and income taxes… for the first time ever. (Don’t be fooled by the brevity of this section. This was a momentous political event.)
The Great Depression
Maybe the peak of resurgent tariff politics was the 1930 Smoot-Hawley Tariff, made famous in later years as the subject of Ben Stein’s lecture in the movie Ferris Bueller’s Day Off. This increased tariffs on more than 20,000 goods in the United States. After the dust settled from other countries retaliating, imports had fallen 67% in the U.S. Add to it the collapse of the banking system, with a third of the banks going out of business by 1933, the Dust Bowl, and some bad policy decisions, and America ended up with the worse economic decline in its history. Franklin Roosevelt ran against the tariffs and started to reduce them, but everything was put on hold due to World War II.
Post-War Era
After the war, a wave of international cooperation among the Western countries emerged. Several international organizations were formed, including the General Agreement on Trade and Tariffs, which saw a decrease in tariffs around the world and a general trend of reductions since the late 1940s. The chart below sums up the American tariff experience:
Conclusion
Tariffs have been a mainstay of American trade and economic policy since the nation’s founding. During some periods, they were a major source of revenue for the federal government. During this time, the country grew, becoming the world’s largest economy by the 1890s. However, the past is not a prologue. From 1789 to 1913, the U.S. had no federal income tax, so while tariffs have been higher generally — and very high at times — overall tax burdens were not. Plus, the international component of the American economy was small (imports and exports were around 5% of GDP), and the size of government was small, also consuming less than 10% of GDP, with almost no debt. Events of the first half of the 20th century changed everything. After the Progressives, two wars and the Great Depression, we were different. Modern government consumes 13% of GDP, double that when we include transfer programs. It also has a $35 trillion debt, imposes a variety of taxes with a higher overall tax burden, and imports 14% of GDP, while exporting 11%. It’s a different world, and tariffs have different purposes and impacts today, which I discuss in the second installment of this essay.
[1] https://www.archives.gov/founding-docs/declaration-transcript
[2] https://www.cambridge.org/core/journals/journal-of-economic-history/article/abs/aftermath-of-hamiltons-report-on-manufactures/F98753CE4F700F4B334BEC89F52EC29E
