McKinley’s Recantation

A brief history and analysis of tariff policy

Introduction

Recently, a reader of a note I posted on the subject of the incoherence of tariff policy asked me about an earlier note I had written on the subject.  I couldn’t find it. I have since found it and it appears again at the foot of this essay.  I am vehemently opposed to tariffs not because they are advocated by Trump, though that would be reason enough to engender opposition.  My view is founded in personal experience.  More years ago than I care to remember I liquidated companies at the behest of the Customs Service.  Two in particular had cheated the tariffs which, I found to my horror, was easily done as I explain in the original note.  There is a kind of Gresham’s law which takes hold.  If one person is able to manipulate the base cost for the tariff then its competitors will either be driven from the field or succumb to illegality.

My reader then asked me to relate what I say to the historical context, namely the role McKinley played in implementation of tariffs at the end of the 19^th century.  She was, of course, referring to Trump and his wild claims.  I determined to look into the history and what I found was very interesting.

A little history

The rationale for tariffs underwent a significant change in the 19^th century.  Initially, the purpose was to raise governmental revenues as had been traditional amongst many governments over centuries.  As new forms of revenue raising took hold Customs duties began to fade in importance.  During the 19^th century it occurred to policy makers that tax on income would be more lucrative, more easily enforced and be progressive in imposing the burden.  Britain was first to adopt it and by mid-century its colonies and other Europeans had implemented it.  There was, or there was perceived to be, a constitutional impediment in the US to income tax.  Nonetheless federal income tax began in the 1890s.  All doubt was removed when the 16^th Amendment was ratified.

Tariffs were in place when the United States became the dominant economy in the world, eclipsing Britain by the turn of the century.  Some thought there was not just correlation but causation between the two.  For example, in 1890 Willian McKinley, then a congressman, stated:

We lead all nations in agriculture, we lead all nations in mining, and we lead all nations in manufacturing. These are the trophies which we bring after twenty- nine years of a protective tariff. Can any other system furnish such evidences of prosperity?

McKinley was an enthusiast for tariffs and the watershed Tariff Act of 1890 bears his name.  The debate leading up to the 1890 Act was characterised, in part, by discussion of what to do with increasing federal surpluses.  A debate of that sort sounds alien to the modern ear.  The theory seems to have been that to raise tariffs to an extortionate rate would choke off imports, thereby reducing federal revenues and give the added advantage of protection of American manufacturing.

The effect of the McKinley Tariff was to impose a tariff of 50% upon a range of imports.  Tariffs were in place before but the rates of imposition were lower.  Unsurprisingly prices of goods subject to impost rose. Equally unsurprisingly the political party advocating higher tariffs became unpopular and it lost in the next election.  Subsequently, tariffs were lowered again.

McKinley’s proposition relating to the central role tariff policy played in stupendous economic growth is highly dubious.  Other factors include the abundance of natural resources, technological change and, above all, immigration.  Between 1870 and 1900 12 million immigrants entered the United States.  Maybe it is an irony that the true economic locomotive in the late 19^th century is the influx of people eager to prosper in a new land.  To isolate tariff policy as the primary cause of economic growth is foolish.  Far more significant was the population explosion happening simultaneously.  There is a bitter irony that the present-day proponents of implementing tariffs have misunderstood the history absolutely.  Even McKinley had a change of heart and recanted a decade after his Act was passed. 

In a speech a day before he fell to the assassin’s bullet, McKinley gave a speech in which he advocated what would now be called globalisation to promote export of US manufactures.  He said:

The period of exclusiveness is past. The expansion of our trade and commerce is the pressing problem. Commercial wars are unprofitable. A policy of goodwill and friendly trade relations will prevent reprisals. Reciprocity treaties are in harmony with the spirit of the times; measures of retaliation are not. If perchance some of our tariffs are no longer needed for revenue or to encourage and protect our industries at home, why should they not be employed to extend and promote our markets abroad?

Exactly, he recognised that free trade was greatly beneficial.  I don’t think the assassin, who was an anarchist from memory, had the slightest interest in the maintenance of protection.  McKinley’s death and his recantation are corelative not causatively related.  As for Trump, self-evidently he does not understand the history that he refers to.  He should draw the exact opposite conclusions to those that he does. 

The folly of Customs duties

As noted, I wrote before about the difficulties in enforcing Customs duties.  This is, lightly edited, what I wrote.

Trump claims, or seems to, that under his administration income tax will be replaced by tariffs on imports.  There can be no more stupid proposal imaginable.  On their face tariff regimes are easy to implement.  Usually they are ad valorem, meaning that the impost is a percentage of a pre-determined base value.  The base value is usually cost to the importer.  The first problem is to establish the appropriate cost to use.  The basis to cost has multiple variations from ex-works to free alongside ship (FAS) to cost, insurance, freight. 

Once the appropriate value has been determined the next problem is how to determine what it is.  It seems most likely that it should be based on the invoice from the vendor to the purchaser.  Of course, that invites manipulation.  The most obvious way to manipulate would be for the vendor to establish an off-shore company which is the importer.  The offshore company would then buy the items to be imported at a deep discount and then add the profit margin within the importing jurisdiction.  It would pay no tax on its earnings or its remittances as there would be no income tax to apply.  For each avoidance device, and there will be many, an anti-avoidance measure will be devised.  Compliance costs will mount and, eventually, overwhelm.  The honest will be driven from the field leaving it to the dishonest to make super profits. 

It will soon be discovered that some imports are vital to the economy and have no domestic competitor.  Rare earth elements may be an example.  Exceptions will need to be made.  The is a classification system for this purpose.  It is called the harmonised code or, colloquially, the tariff.  It comprises millions of categories of items, the distinctions among many of them can be very faint.  Misclassification, both deliberate and inadvertent, ensues leading to ever mounting administrative cost.

Very soon he who would impose tariffs would start to realise that they were severely damaging their own interests by damaging friends and allies or simply to themselves because of retaliation.  Preferences for countries of origin would be introduced.  Another opportunity to skirt round the impost would have been presented.

Because of the administrative burden a de minimis rule would need to be considered for items in small numbers and of low value.  With the advent of on-line sales much business is done this way.  If an exception is made for low volumes or low values then retailers in low-cost jurisdictions will have an insurmountable advantage compared to domestic retailers.

Customs duty regimes rarely work as intended.  They encourage delinquency and eventually collapse under their own weight.

Sources

Douglas A Irwin “Higher Tariffs, Lower Revenues?” Journal of Economic History (trace PDF from Wikipedia entry on The McKinley Tariff)

Douglas A Irwin Chapter 6: “Protectionism Entrenched, 1890– 1912” of Clashing over Commerce: A History of U.S. Trade Policy [Chicago University Press]

Library of Congress website “Immigration to the United States: 1851 to 1900”

Document: William McKinley: Reciprocal Trade Agreement

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