Trump’s ‘beautiful’ tariffs will weaken trade and worsen inequality

President Trump’s new favorite word is “tariffs.” Like a kid with a new shiny toy, he seems fascinated and has declared that “tariff” is “the most beautiful word in the dictionary.”

As is often the case, Trump’s loose use of language complicates understanding. But there seems to be several things at work in his fascination with tariffs and promise to impose massive taxes on virtually all U.S. imports, about $4 trillion a year.

Trump's fixation on tariffs appears motivated in large part by the U.S. trade deficit — that is, the fact that we buy more from our international partners than we sell to them. There are multiple reasons for this, and trade deficits reflect U.S. consumers enjoying the benefits of foreign goods.

Obviously, a completely balanced trade with every nation is impossible, and the comparative advantage that drives international trade is a boon to all trading nations, making all of us wealthier. But when foreign government policies promote the trade deficit, it is unfair to American workers and a cause for serious concern.

Increasingly, Trump is fixated on other nations’ value-added taxes as the real source of the deficits (although he sometimes simply mislabels them as tariffs). And foreign value-added taxes do pose a serious economic challenge for American companies.

Value-added taxes are common around the world; they are a type of consumption tax, similar to a sales tax. The difference is that they are collected at every level of production, not just final sale.

For example, a company making bikes might buy $50 of metal and parts and sell the bike to a wholesaler for $100. Having added $50 in value, a 10 percent value-added tax would charge $5. When the wholesaler sells to a retailer for $150, the wholesaler also pays $5. When the retailer sells to a consumer for $300, having added $150 in value, the tax is $15.

In theory, these taxes are easier to monitor and collect, with clear paper trails that minimize fraud. In broad terms, the alternative to funding the government with such consumption taxes is to impose income taxes, the primary federal revenue source in the U.S.

What makes value-added taxes relevant to trade deficits is that nations refund them on exports and impose them on imports. Exports are thus encouraged, and imports are made to bear part of the nation’s tax burden. This appears to be what motivates Trump’s tirades.

And he is correct that the use of value-added taxes by many of our trading partners disadvantages the U.S. in world trade.

Even so, his proposed solutions make little sense.

First, Trump blusters about imposing across-the-board massive tariffs on all imports, but the problem varies greatly from country to country. In Canada, the value-added tax (called a goods and services tax) is only 5 percent; provinces add their own value-added taxes for a combined rate as high as 15 percent. Obviously, U.S. states also impose their own taxes that have to be added to federal obligations to make a fair comparison.

In Europe, value-added taxes range from 18 percent to 25 percent in the European Union to only 8 percent in Switzerland. Even this is simplistic, as reduced rates are available for many imports. In Korea, it is generally 10 percent, but is also subject to exceptions; the same is true in Japan.

Regardless, the fact that the United States depends primarily on income taxes while our leading trading partners rely on value-added taxes does disadvantage U.S. trade and should be a matter of serious consideration in Washington.

Of course, the U.S. could respond by imposing one of its own, encouraging exports with refunds while discouraging imports.

Unfortunately, tariffs are a poor substitute for a value-added tax. For starters, the United States has entered into numerous international agreements binding our tariffs at current levels. Imposing new tariffs not only violates our legal obligations but undermines the international trading system that has served the United States, and the world, well.

Trade wars will diminish our wealth, and the world’s. It is worth remembering that the Smoot-Hawley Tariffs played a part in the Great Depression.

If Trump is serious about addressing the issue, he would demand the Republican Congress consider a value-added tax. That, though, would raise a very serious problem for the United States.

Both tariffs and value-added taxes are consumption taxes, imposed on goods and services that people buy. But consumption taxes are generally regressive — meaning that poor people end up spending a higher share of their disposable income on taxes than do rich people (who put money into savings or consuming items not subject to such taxes, for example, expensive foreign trips).

By comparison, the very nature of an income tax is progressive: People with higher income — having profited immensely from the success of the economy — pay a higher rate. Although some new studies seek to show that consumption taxes are not as regressive as economists generally understand, they certainly do not have the progressive characteristics of an income tax.

While it may make sense for the United States to discourage imports and encourage exports with a value-added tax, such a system or higher tariffs both threaten to increase the already exploding American wealth inequality gap. Such concerns must be addressed.

America’s wealth gap – the difference between how much of the nation’s wealth is held by the rich and other classes — is exploding. It accelerated massively with Trump’s 2017 tax cuts that almost all went to the wealthy — tax cuts for the rich that Republicans are planning on renewing, further ballooning the wealth gap.

This is not simply a matter of the rich earning well-deserved success. Today, in the United States, the richest one-tenth of one percent (320,000 people) has six times the wealth of the bottom 50 percent ($160 billion). The top 1 percent had essentially the same wealth as the bottom 90 percent.

This type of wealth inequality is dangerous in a democracy.

Thomas Jefferson saw it, warning of “the consequences of this enormous inequality producing so much misery to the bulk of mankind.” Jefferson understood that if inequality ran rampant, if American citizens did not feel that they were sharing in the nation’s success, it threatened political stability. If inequality exploded, “legislators cannot invent too many devices for subdividing property.”

Having seen terrible poverty and obscene wealth in France, Jefferson begged America to avoid that disaster. If wealth inequality grows too large, we should “exempt all from taxation below a certain point, [and] … tax the higher portions of property in geometrical progression as they rise.”

If Trump continues to focus on increasing consumption taxes as he cuts taxes for the super-rich, the wealth gap will continue to blow up. This is exactly what would happen with his proposal to eliminate the income tax — creating a tax system for the rich by the rich.

Jefferson lived through the beginnings of the French Revolution, and he understood that exploding wealth inequality would not end well. When ordinary people see that they are no longer sharing in the nation’s success, they will demand action. What he saw in France suggests that Luigi Mangione may be just a start.

A government by billionaires for billionaires may make sense to the billionaires, but it is dangerous to Americans.

Trump’s fixation on tariffs feeds that danger.

John Ragosta, Ph.D. represented U.S. industries in international trade disputes for 20 years before earning his Ph.D. in American-constitutional history. Formerly the acting director of the International Center for Jefferson Studies at Monticello, his most recent book is “For the People, For the Country: Patrick Henry’s Final Political Battle.”

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