Fundamental patterns in any kind of system are difficult to break. There is nothing new under the Sun, per Ecclesiastes. When an income-tax cut became law last December, it fit the pattern of history when the slew of tariffs the presidential administration put on foreign goods came in summer. It is the manner of American history: when the income tax wanes, the tariff waxes, and vice versa.
The first income tax was modest.
In recent times—the last hundred or so years—the income tax has trounced the tariff in grabbing its share of proportionality. Over the free-trade era, from Franklin D. Roosevelt in the 1930s through Barack Obama in the 2010s, when generally tariffs went down, the income tax stormed ahead. It grew from nil to such enormity that compliance costs (not the tax itself) run greater than the GDP of nations not among the twenty richest in the world.
Who benefited from this development? Government. The feds benefited from free trade, by what it brought in return, an income tax that deadens the private sector and siphons off unheard of capital to Washington. Free trade, in theory and practice, is a beautiful cause, a great, perfect, and essential thing. But it appears to have a major unfortunate consequence in application. It appears to bring with it a far worse system of taxation. This nasty problem is the main issue in the history of American political economy, true today as it ever was.
The connection is morbidly constant. The United States opted for a tariff over an income tax in 1789, dispensed with excise taxes and soon left the tariff as the sole means of taxation until 1861. After the civil war, along with the tariff there were domestic taxes on alcohol. There was no income tax until 1913, when in the very same law, the tariff was cut by a third in exchange for an income tax on high earners of 1-7 percent.
During World War I, the tariff became a dead letter, as income-tax rates soared to 77 percent. In the 1920s, income-tax reductions came with increases in the tariff. In the early 1930s, the income tax and the tariff went up jointly for the first and only time, causing the Great Depression. FDR shook tariffs downward, and loaded high rates into the income tax.
The tight connection is no simple correlation. The nation opted for a tariff in the greater nineteenth century, and for an income tax in lieu of it in the 20th century and beyond.
Two questions arise: why the switch, and why the trade-off in the first place?
In the 1960s, public choice economists and political scientists including Gordon Tullock and Mancur Olson outlined theories of motivations the government might have regarding different forms of taxation. The tariff is desirable because it collects taxes from foreigners as opposed to the domestic population, making that population quiescent. The tariff is undesirable because high rates chase away taxpayers, and it reels in at most only 3 percent of GDP. Another problematic aspect of the tariff, from the government’s perspective, is that as a list of specific taxes on foreign products, it exposes the cronyism between domestic businesses and Congress, leaving government in lower esteem.