The Debate On Tariffs Ignores A Very Big Issue—The Tax Wedge

Key Concepts:

• Tariff: A tax on imported goods or services.
• Tax Wedge: An obstacle or barrier between buyer and seller created by taxes.
• Inflation: A general increase in prices and fall in the purchasing value of money.
• Supply Chains: A network between a company and its suppliers to produce and distribute a specific product to the final buyer.
• Smoot-Hawley Tariff Act: A U.S. law enacted in 1930 that raised tariffs on thousands of imported goods.
• Beggar-thy-neighbor policies: Economic policies that benefit one country at the expense of others.
• Competitive Devaluations: A situation where countries lower the value of their currency to make their exports more competitive.

1. The Tax Wedge Effect of Tariffs

• Steve Forbes introduces the concept of a tariff as a tax, which creates a "tax wedge" between buyers and sellers.
• The size and breadth of the tax wedge determine its harmfulness.
• Example: A person earning $40/hour needs to work 5 hours to buy a $200 item with no income tax. With a 50% income tax, they only keep $20/hour and must work 10 hours for the same item.
• The current tariff discussions focus on inflation, but Forbes argues that the "wedge," or barrier to doing business, is the bigger issue.
• Tariffs add friction to business, and the magnitude depends on the rates, extent of application, and effect on supply chains and trade patterns.

2. Tariffs and Economic Prosperity

• Forbes argues that tariffs don't necessarily raise overall prices, but they increase the effort required to buy goods, leading to less prosperity.
• He criticizes the Federal Reserve's focus on the inflationary impact of tariffs, suggesting they should concentrate on the friction imposed on commerce.

3. The Smoot-Hawley Tariff Act as a Historical Example

• The Smoot-Hawley Tariff Act of 1930 is presented as a devastating example of the negative impact of tariffs.
• The act imposed tariffs on thousands of items and triggered retaliatory measures from other countries, effectively destroying the global trading system.
• The resulting decline in trade contributed to the Great Depression, along with other economic mistakes like tax increases and competitive devaluations ("beggar thy neighbor policies").
• Key Point: The Smoot-Hawley tariffs didn't raise prices initially; the slump in commerce led to price cuts.

4. Post-World War II Trade Liberalization

• After World War II, the US led a series of agreements to reduce tariffs and trade barriers.
• This resulted in an explosion of trade, which was critical for the significant economic growth experienced after 1945.

5. Current Tariff Situation and Concerns

• Forbes acknowledges that current tariffs are not yet on the scale of Smoot-Hawley and are still subject to change.
• However, he expresses concern that the focus on inflation obscures the real issue: the tax wedge.
• He hopes that current tariffs are negotiating tactics that will lead to sensible agreements and reduced trade barriers.

6. Conclusion

• Forbes emphasizes the importance of remembering the impact of the tax wedge on economic growth.
• He encourages viewers to send in comments and suggestions.

Key Quotes:

• "A tariff is a tax, and a tax is a wedge, an obstacle between buyer and seller." - Steve Forbes
• "That's why the focus on inflation misses the bigger issue. Tariffs don't necessarily raise overall prices...but the effort required to buy it will. That means less prosperity." - Steve Forbes
• "The most devastating result historically came from the sweeping Smoot Holy tariff bill...triggering the infamous stock market crash." - Steve Forbes

Technical Terms and Concepts:

• Tariff: A tax imposed on imported goods or services.
• Tax Wedge: The difference between the pre-tax cost of something and the post-tax cost, representing the barrier to economic activity.
• Beggar-thy-neighbor policies: Economic policies that benefit one country at the expense of others, often through protectionism or currency manipulation.

Logical Connections:

• The video starts by defining tariffs and the tax wedge, then illustrates the concept with a simple example.
• It connects the current tariff discussions to the historical example of the Smoot-Hawley Tariff Act to demonstrate the potential negative consequences.
• It contrasts the pre- and post-World War II trade environments to highlight the benefits of trade liberalization.
• The video concludes by reiterating the importance of understanding the tax wedge and hoping for a positive outcome from current trade negotiations.