A Scaled Tariff Would Help Balance the 2011 Budget

The last Congress passed a dangerous mixture of spending increases and tax cuts financed by borrowing.  The American people saw this as a mistake and in the 2010 elections elected a Republican House of Representatives and an increased number of Republican senators.  In the exit polls, 40 percent of voters said that the highest priority should be reducing the budget deficit (65 percent of them voted Republican).  As a result, the Republicans were given a mandate to balance the federal government budget.

But the United States faces not only a huge budget deficit, but also a huge foreign trade deficit.  A December 2010 National Review/Allstate Heartland Poll contained an extensive battery of questions on trade and U.S. manufacturing.  The poll revealed strong public majorities in favor of a variety of measures that would move trade towards balance.  For example, 68 percent of respondents supported a policy requiring that "a certain percentage of every high-end manufactured product, such as automobiles, heavy machinery, and transportation equipment, sold in the U.S. also be produced or assembled within the U.S., even if that means higher prices for their products."  In 2006 and 2008, the Democrats won elections by advocating protectionism.  The conservative pro-free-market alternative is balanced trade.  When trade again becomes a dominant issue, Republicans could go back to minority status unless they address the trade issue themselves.

The two deficits -- budget and trade -- are easier to balance simultaneously than to balance separately.  Balancing budgets reduces demand for American products, but balancing trade increases it.  Balancing trade increases long-term interest rates, but balancing budgets reduces them.  Moreover, the government revenue from tariffs that balance trade would help balance budgets!

The most effective way to balance trade is through a scaled tariff.  Its rate with each trade surplus country goes up when our trade deficit with that country goes up, down when our trade deficit with that country goes down, and disappears when trade with that country gets close to balance.  As a result, it would not only reduce American imports, but it would also increase American exports by forcing our trading partners to take down their barriers to our products so that they could continue to sell us their products.

Tariffs endorsed by the U.S. Constitution

Import duties, such as the scaled tariff, were envisioned by our founding fathers as one of the major ways to balance the federal budget.  Article 1, Section 8 of the United States Constitution begins thus: "The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts."

Although free trade is a worthy goal, it is not as important as balanced trade.  The purpose of trade is to exchange a bundle of goods and services produced with comparative advantage in one country for a bundle of goods and services produced with comparative advantage in the other country.  When trade is in balance, both trading partners benefit.  But when trade is chronically out of balance, the trade deficit country loses jobs in import-competing sectors without gaining more productive jobs in exporting sectors.

During the third quarter of 2010, our trade deficit was running at a $550-billion-per-year pace.  Since trade-oriented jobs generate about $100,000 in revenue each, if trade were balanced, the United States would gain about 5.5 million productive new jobs.

Scaled tariff endorsed by WTO agreement

The United States and all other nations experiencing large, chronic trade deficits are entitled under World Trade Organization (WTO) rules governing international trade to impose barriers to imports from their offending trading partners.  This rule was partly designed to insure steady growth in world trade.  Balanced trade can grow forever, but imbalanced trade eventually bankrupts the trade deficit countries, ruining the markets for the trade surplus countries.

Article XII of GATT 1994, annexed to the Agreement Establishing the World Trade Organization, permits any country that has both a perilous external financial position and a balance of payments deficit in the current account to restrict the quantity or value of merchandise permitted to be imported in order to bring payments toward balance.  With the United States net foreign debt in 2009 at 25% of GDP and the balance of payments deficit in the current account at 2.7% of GDP, the United States qualifies and is permitted to use import restrictions to balance trade.  Such restrictions can include price-based measures such as import duties in excess of the duties inscribed in the WTO schedule for that member.

Countries that impose import duties under Article XII of GATT 1994 must progressively relax such import duties as the trade deficit grows smaller, maintaining duties only to the extent that a continuing balance of payments deficit in the current account justifies such application.  Therefore, an import duty that is implemented under the authority of Article XII of GATT 1994 should go down in rate as trade approaches balance and should disappear when the balance of payments in the current account reaches balance or goes into surplus.

The scaled tariff complies with Article XII of GATT 1994 because it is suspended if the United States balance of payments in the current account goes to surplus and because its rate goes down when the United States trade deficit with a country improves.

Simplicity of the Scaled Tariff Bill

Bills passed by the last Congress often numbered thousands of pages in length; in contrast, a scaled tariff bill would be extremely short.  In fact, we have written up a scaled tariff bill that is only four pages in length, and two of those pages are the preamble!

The scaled tariff would be applied only to countries that had a sizable trade surplus with the United States over the most recent year (four economic quarters).  The duty on imported goods from that country would be designed to collect, as government revenue, half of the value of the trade deficit (goods plus services) with that country.  The Commerce Department would simply charge the scaled tariff at the appropriate duty rates to imported goods from the trade surplus countries and rebate scaled tariff payments to the United States exporters to the extent that they were paid on inputs to those particular exports.

The Commerce Department publishes complete trade data (both goods and services) with twenty countries.  We can calculate from these data for the last four economic quarters that eleven of these countries would not have any duty applied to their goods (Argentina, Australia, Belgium, Brazil, Canada, Hong Kong, Luxembourg, Netherlands, Singapore, South Korea, and the United Kingdom), while the other nine would have the following initial duty rates applied:

  • China - 36%
  • Venezuela - 28%
  • Italy - 25%
  • Germany - 24%
  • India - 22%
  • Japan - 16%
  • South Africa - 14%
  • Mexico - 13%
  • France - 12%
  • Taiwan - 8%

A duty of 36% on Chinese goods is just about right since the Chinese yuan is about 40% undervalued.  A 13% duty on Mexican goods is also about right since Mexico has been placing tariffs on U.S. goods lately while intervening in foreign exchange markets to keep the peso undervalued.

Economic benefits of the scaled tariff

If trade levels did not change, the tariff on just the countries listed above would take in $226 billion in revenue, enough to make a sizable dent in the federal budget deficit.  But trade levels with these countries would change.  As revenue from the scaled tariff declines, income earned by U.S. producers would rise.  Eventually, trade would come into balance, ending the revenue from the scaled tariff while producing income tax revenue from about 5.5 million new and highly productive American jobs.

The initial economic benefit of the tariff would be a surge in the building of highly efficient factories in the United States.  International corporations would locate new factories here so that they would be on the right side of America's tariffs.

A longer-term benefit would be the preservation of the dollar as the world's reserve currency.  Over the past three decades, America's chronic trade deficits have converted the U.S. from the world's leading creditor nation to the world's leading debtor nation.  This has led the BRIC nations (Brazil, Russia, India, and China) to suggest that a new currency be created to replace the dollar, presumably a currency issued by the International Monetary Fund, like its so-called "drawing rights."  Once replaced, the dollar would collapse in value.

But the biggest benefit of all would be to world freedom.  Currently, totalitarian China manipulates the dollar-yuan exchange rate while placing tariff and non-tariff import barriers against American products so that it can grow its trade surplus with the United States.  As a result, its economy grows at about 10% per year, while the U.S. economy grows at about 2.5% per year.  If Congress were to pass the scaled tariff, the renewed success of the United States economy would likely turn China democratic.

On the other hand, if the new Congress wimps out and lets our budget and trade deficits stay high and chronic, the Chinese Communists will prove their argument that democracies cannot solve their own economic problems.  The only question will be this: which disaster will precipitate the American crash -- spiking interest rates caused by the budget deficits or a collapsing dollar caused by the trade deficits?

The authors maintain a blog at www.idealtaxes.com and co-authored the 2008 book Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late, published by Ideal Taxes Association.