(This item originally appeared at Forbes.com on February 13, 2025.)
The United States was founded on Free Trade. And, high tariffs.
Free Trade applied between the States. The new Federal Government was given specific powers over Interstate Commerce, to prevent the States from erecting tariff barriers against each other. States were not allowed to establish their own tariffs on foreign trade. The Federal Government applied a uniform tariff throughout the United States. It was one of the principal sources of revenue, in the Nineteenth Century.
Domestically, the United States had exceptional economic policy. There were hardly any taxes, and the currency was reliably fixed to gold. Trade was Free between States. With what I’ve called “The Magic Formula” (Low Taxes and Stable Money), the US got rich – even with high tariffs with the rest of the world.
Immigration was highly restricted during the first half of the Nineteenth Century. No significant immigration took place until a burst of Irish immigrants, fleeing the Irish famine and British oppression, in the 1840s. In 1830, 98% of the US population was native-born. Even until 1890, almost all immigration came from Britain, Ireland, Canada, and Germany (England’s medieval ancestors).
The tariffs themselves were extremely problematic, however. They invited extreme overcomplexity, with different tariffs for different goods, and even for different countries, with rates that changed suddenly. Every tariff rate became an object of political contention. High tariffs were an object of chronic disagreement between the North and South, which was only exacerbated when the election of Abraham Lincoln resulted in still-higher tariffs.
During the Nineteenth Century, the United States ran a persistent current-account deficit with the rest of the world, which basically reflected the desire of foreigners to invest in the booming United States.
This arrangement changed with the introduction of the Income Tax in 1913. Now, there was an alternative to using tariffs to raise revenue. The Revenue Act of 1913, which introduced the first peacetime Income Tax, also reduced tariffs from an average of 40% to 25%.
Tariffs rose again with Republican administrations, especially as the Smoot-Hawley Tariff of 1930 kicked off a global trade war. As the Great Depression and the World War that followed drew to a close, at Bretton Woods in 1944, the nations of the world agreed that they would turn away from 1930s-style protectionism and toward Free Trade. An International Trade Organization was planned, to go along with the World Bank and International Monetary Fund that was created at Bretton Woods. The ITO wasn’t ratified, and devolved into the weaker General Agreement on Tariffs and Trade that eventually became the World Trade Organization in 1994.
With the North American Free Trade Agreement of 1994, and the World Trade Organization the same year, the creation of the Eurozone in 1999, and many similar steps of that time, the modern era of Globalization began. China’s admission to the WTO in 2001 was a landmark in the Globalist explosion that followed, further enabled by the Internet and all the other communications and transportation advances that made super-long supply chains possible.
Just as economists say, this reduction of barriers to trade helped make the world rich. The position of China or India today, compared to the situation in 2000, has been vastly improved. All global measures of poverty have had enormous improvements.
However, it has not made America rich – in particular, the incomes of the lower 50% or 70% of Americans, which have stagnated for decades. These Americans have had to compete against all the cheap labor in the world. Along the way, as all barriers were reduced, the process of Specialization and Trade has resulted in huge swathes of the economy that has essentially gone overseas – an arguably perilous position for a large country that wants to maintain a world leadership role.
Now people have to ask: If an economic policy does not result in better outcomes for Americans, then what, exactly, makes it “good”?
And what, exactly, should we do about it?
These are interesting questions, for which there is almost no framework of inquiry to begin answering them. Economists have almost nothing to offer besides mouthing platitudes that they were taught in school. I’ve taken some time to begin to address these issues in a rational and analytic way.
But to summarize my conclusions, and give some useful guidance, I would say that, if we are going to move back toward limiting foreign trade, and foreign immigration, for a dozen reasons you can name, then let’s also copy our successful 19th Century Magic Formula.
High Tariffs, by themselves, didn’t make us rich. If there’s something we got right in that time, it was not high tariffs, but Low Taxes and Stable Money. The resulting wealth that was created, the people employed at higher and higher wages, made the United States the example that everyone wanted to copy. High rates of domestic capital creation (savings rates) and net domestic investment meant plenty of new businesses starting up to hire anyone who was available.
With the hindsight of history, we can see that neither Tariffs, nor the Income Tax of 1913 that was introduced in part to replace tariff dependence, have been very good policies. What, then, is the best solution we can come up with today? I think it is the Value Added Tax, which also includes, inherent within it, a flat-rate tariff. We have long struggled to avoid having an Income Tax and VAT together, which, as so many countries have shown, easily degenerates into a high-tax disaster. However, if we eliminate the Income Tax, as President Trump sometimes suggests, the VAT is the best replacement.
