There Is No Such Thing as Free Trade Jude Wanniski April 23, 2001

Memo To:Don Evans, Secretary of Commerce
From: Jude Wanniski
Re: Tariffs on the Laffer Curve

One of the most important things every department and agency of the Bush administration should study is the Laffer Curve. Art Laffer, then a professor of economics at the University of Chicago, first drew the curve for Dick Cheney, now our Vice President, on Dec. 4, 1974. It was meant to demonstrate that if you continue to raise taxes, there will come a point where you will so discourage commerce that revenues will decline. It is simply the law of diminishing returns applied to tax policy. It means that there are always two tax rates that will produce the same revenues, one a high rate that extracts resources from a struggling economy, the other a lower rate that draws resources from an expanding economy. The law of diminishing returns should be at the core of every decision of public policy, because government should never do more than is necessary to achieve its goal. On the other side of that idea we can say government should never do less than what is necessary to achieve the goal.

Your Cabinet colleague, Christie Whitman of the Environmental Protection Agency, would do well to think and speak of the law of diminishing returns in every aspect of her work in protecting Mother Earth. There is no question, for example, that if you drink water with lots of arsenic in it, you will die. If you drink water that contains a little bit of arsenic, maybe it is good for you. It could be that Mother Earth has arranged to put a little bit of arsenic in spring water so that it is bad for microbes that would be even worse for birds and animals to consume. There comes a point, we should be able to get scientists to agree, when the number of parts per billion is going to start having adverse effects on human beings, but scientists who do that kind of work are ill-equipped to decide upon the legal standards set by the EPA and our government. If the current standard is 50 ppb and the scientists find that if it is cut to 10 ppb, so many parts per million of people will live longer, we still need to know the cost. If it costs $1 trillion a year to clean the water to that point, we would quickly agree that the nation could not afford the cost.

The reason I direct this memo to you, though, has to do with the concept of “free trade,” which has come to mean that we will be better off as a community of people if we have no tax on transactions between international producers of goods. Now I consider myself a free-trader, but I reject the idea that there should be no tariff on goods coming into the United States. Zero tariffs means zero revenue, and if we are going to have a government, we are going to have to have revenues. In other words, I believe our market should be open to all goods manufactured in the rest of the world, as long as those goods are environmentally sound. (We should import no “mad cows” or “hoof and mouth” livestock.) But as long as we tax American producers of goods who wish to bring their goods to our market, it seems reasonable to me that foreign producers contribute to the general fund.

In my 1978 book, The Way the World Works, I pointed out that if Jones, an American, produces goods that he trades with Smith, who produces other goods, the transaction is taxed by federal, state and local governments. There is a “tax wedge,” a piece of the trade, that goes to support the general needs of the community, in the form of income taxes and property taxes. If Jones produces goods that he trades with Schmidt, a European, why should there be no tax wedge in that transaction? I’m not talking about a protective tariff, Mr. Secretary. I’m talking about a revenue tariff. Our average ad valorem rate on imports now is 6%, but there are a great many items that now come in tax free and other items that come in at much higher rates. The idea we should eliminate our tariff wall in the name of “free trade” generally comes from corporations that make goods for export, as these would expressly benefit from having foreign economies lower their tariff walls.

Ralph Nader and Pat Buchanan, a man of the left and a man of the right, both wound up representing those Americans who work for industries that will not benefit from the elimination of the tariff wall. Our high-tech enterprises export software to China, for example, and the Chinese pay for that software with textiles. There is a point at which the people who make textiles in the United States really are distressed by the changes in the terms of trade that come about by the government shifting taxes and tariffs around. If I were you, I would work on a major reform of the nation’s tariff structure. The only practical way to succeed in such a reform would be to propose a “flat tariff,” perhaps a flat 6% of all goods and services that come into the U.S. market, a kind of price of admission. There has never been such a reform of the tariff system in the United States, which in our earliest days as a Republic was the only place where revenues were collected. There are now several thousand different tariffs, at rates small and large, with some items not taxed at all. If you did try to have differentials, with some tariffs high and others smaller, you would only open another door for lawyers and lobbyists to engage themselves via another zillion dollars in campaign contributions.

My main point, Mr. Secretary, is that the President and his Cabinet represent all the people, which is why you folks, not the Congress, can benefit greatly by setting your arguments in terms of the Laffer Curve of diminishing returns. The 535 members of Congress individually represent exporters or importers, and in other cases represent coastal states that oppose offshore drilling or landlocked states that support offshore drilling. There are states like Connecticut, where there are only traces of arsenic in the water, which makes it easy for Sen. Joe Lieberman [D-CT] to condemn the Bush administration for being anti-environment. Sen. Lieberman says he favors an arsenic limit of 5 ppb. See what I mean? When he was just a Senator from New Jersey, Bill Bradley condemned federal ethanol subsidies as a national economic scandal. When he sought the Democratic presidential nomination, he faced the Iowa caucuses, and so came out in favor of ethanol. There is practically no corn grown in New Jersey. The President can’t really take sides among legitimate competing interests. But he has the law of diminishing returns to fall back upon. You do too.