Tag Archives: Regressive Tax

A Tax On Imports Takes a Toll on Exports

10 Friday Oct 2025

Posted by in Free Trade, Tariffs

≈ Leave a comment

Tags

, , , , , , , , , , , , , , , , , ,

Tariffs have far-reaching effects that strike some as counter-intuitive, but they are real forces nevertheless. Much like any selective excise tax, tariffs reduce the quantity demanded of the taxed good; buyers (importers) pay more, but sellers of the good (foreign exporters) extract less revenue. Suppose those sellers happen to be the primary buyers of what you produce. Because they have less to spend, you also will earn less revenue.

The Lerner Effect

The imposition of tariffs by the U.S. means that foreigners have fewer dollars to spend on exports from the U.S. (as well as fewer dollars to invest in the U.S. assets like Treasury bonds, stocks, and physical capital). That much is true without any change in the exchange rate. However, lower imports also imply a stronger dollar, further eroding the ability of foreigners to purchase U.S. exports.

The implications of the import tariff for U.S. exports may be even more starkly negative. Scott Sumner discusses an economic principle called Lerner Symmetry: a tax on imports can be the exact equivalent of a tax on exports! That’s because two-directional trade flows rely on two-directional flows of income.

Note that this has nothing to do with foreign retaliation against U.S. trade policy, although that will also hurt U.S. exporters. Nor is it a consequence of the very real cost increase that tariffs impose on U.S. export manufacturers who require foreign inputs. That’s a separate issue. Lerner Symmetry is simply part of the mechanics of trade flows in response to a one-sided tariff shock.

Assumptions For Lerner Symmetry

Scott Sumner enumerated certain conditions that must be in place for full Lerner Symmetry. While they might seem strict, the Lerner effect is nevertheless powerful under relaxed assumptions (though somewhat weaker than full Lerner Symmetry).

As Sumner puts it, while full Lerner Symmetry requires perfect competition, nearly all markets are “workably competitive”. In the longer-run, assumptions of price flexibility and full employment are anything but outlandish. Complete non-retaliation is an unrealistic assumption, given the breadth and scale of the Trump tariffs. Some countries will retaliate, but not all, and it is certainly not in their best interests to do so. The assumption of balanced trade is one and the same as the assumption of no capital flows; a departure from these “two” assumptions weakens the symmetry between tariffs and export taxes because a reduction in capital flows takes up some of the slack from lower revenue earned by foreign producers.

Trump Tariff Impacts

So here we are, after large hikes in tariffs and perhaps more on the way. Or perhaps more exceptions will be carved out for favored supplicants in return for concessions of one kind or another. All that is economically and ethically foul.

But how are imports and exports faring? Here I’ll quote the Yale Budget Lab’s (YBL) September 26th report on tariffs, which includes the chart shown at the top of this post:

“Consumers face an overall average effective tariff rate of 17.9%, the highest since 1934. After consumption shifts, the average tariff rate will be 16.7%, the highest since 1936. …

The post-substitution price increase settles at 1.4%, a $1,900 loss per household.“

The “post-substitution” modifier refers to the fact that price increases caused by tariffs would be somewhat larger but for consumers’ attempts to find lower-priced domestic substitutes. Suppose the PCE deflator ends 2025 with a 2.8% annual increase. The YBL’s price estimate implies that absent the Trump tariffs, the PCE would have increased 1.4%. If that seems small to you (and the tariff effect seems large to you), recall that monetary policy has been and remains moderately restrictive, so we might have expected some tapering in the PCE without tariffs.

We also know that the early effects of the tariffs have been dominated by thinner margins earned by businesses on imported goods. Those firms have been swallowing a large portion of the tariff burden, but they will increasingly attempt to pass the added costs into prices.

But back to the main topic … what about exports? Unfortunately, the data is subject to lags and revisions, so it’s too early to say much. However, we know exports won’t decline as much as imports, given the lack of complete Lerner symmetry. YBL predicts a drop in exports of 14%, but that includes retaliatory effects. In August the WTO predicted only about a 4% decline, which would be about half the decline in imports.

Seeking Compensatory Rents

More telling perhaps, and it may or may not be a better indicator of the Lerner effect, is the clamoring for relief by American farmers who face diminished export opportunities. As Tyler Cowen says, “Lerner Symmetry Bites”. Other industries will feel the pinch, but many are likely preoccupied with the more immediate problem of increases in the direct cost of imported materials and components.

The farm lobby is certainly on its toes. The Trump Administration is now asking U.S. taxpayers to subsidize soybean producers to the tune of $15 billion. Those exporting farmers are undoubtedly victimized by tariffs. But so much for deficit reduction! More from Cowen:

“Using tariff revenue to subsidize the losses of exporters is a textbook illustration of Lerner Symmetry because the export losses flow directly from the tax on imports! The irony is that President Trump parades the subsidies as a victory while in fact they are simply damage control for a policy he created.“

A List of Harms

Tariffs are as distortionary as any other selective excise tax. They restrict choice and penalize domestic consumers and businesses, whose judgement of cost and quality happen to favor goods from abroad. Tariffs create cost and price pressures in some industries that both erode profit margins and reduce real incomes. For consumers, a tariff is a regressive tax, harming the poor disproportionately.

Tariffs also diminish foreign flows of capital to the U.S., slowing the long-term growth of the economy as well as productivity growth and real wages. And the Lerner effect implies that tariffs harm U.S. exporters by reducing the dollars available to foreigners for purchasing goods from the U.S. In these several ways, Americans are made worse off by tariffs.

We now see attempts to cover for the damage done by tariffs by subsidizing the victims. A “tariff dividend” to consumers? Subsidies to exporters harmed by the Lerner effect? In both cases, we would forego the opportunity to pay down the bloated public debt. Thus, the American taxpayer will be penalized as well.

Inflation: The Leftist “Tax the Poor” Policy

23 Thursday Sep 2021

Posted by in Deficits, Inflation, Redistribution

≈ 2 Comments

Tags

, , , , , , , , , , , , , , , , , , , , , , , ,

Recent years have seen explosive growth in federal deficits along with growth rates in the money supply that would have made John Maynard Keynes blush. It’s no coincidence that a new school of thought has developed among certain “monetary economists”. But as someone trained in monetary economics, I wish I could make those quote marks larger. This new school of thought is known as Modern Monetary Theory (MMT), and it asserts that the money spigot is a perfectly legitimate means of financing government spending and, furthermore, that it is not necessarily inflationary. Here is how Scott Sumner and Patrick Horan describe MMT:

“A central idea of MMT is that a government that issues its own fiat currency can pay its bills in that same currency. These governments need not worry about budget deficits when contemplating additional spending. Thus because the US government has a monopoly on money creation, our federal government does not need to raise all its revenue through tax or bond finance. A government with its own currency cannot go bankrupt because it can always issue more currency to cover any budget deficit. … MMT advocates argue that this why the US government can afford expensive programs such as a jobs guarantee and universal healthcare.”

Spend and Print

Joe Biden’s $3.5 trillion “social infrastructure” package would be just a start, but that’s likely to be more like $5.5T once the budget gimmicks are stripped out. We can be somewhat hopeful, because that initiative looks increasingly likely to fail in Congress, at least this time around. But the tax side of that bill was already $2.6T short of the latter spending figure, and the tax provisions keep shrinking. Now, it’s looking more like a shortfall of $3.5T would require financing. Moderate Democrats may not support this crazy bill in the end, but Dems from deep blue states want to reinstate state and local tax deductibility, which would cut the tax component still more. Well who cares? Print the money, say the brave MMT advocates.

Sumner gets to the heart of the problem in this piece. Progressives, with false assurance from MMT, want loose monetary policy to make their expansive programs “affordable”. As he explains, if this happens while the economy is near its production potential, inflation is a sure thing. These lessons were learned long ago, but have been conveniently forgotten by the political class (or they simply prefer to ignore them), instead jumping onto the MMT bandwagon.

Inflation Is Taxation

No conscientious observer of government finance should ever forget that inflation is a form of taxation. Assets whose values are either fixed or subject to some inertia are devalued by inflation in terms of purchasing power, or in real terms, as economists put it. Strictly speaking, this is true when inflation is unexpected… if it is expected, then lenders and borrowers can negotiate terms that will compensate for these changes in real value. But when inflation is unexpected, the losses to lenders are offset by gains to borrowers. Of course the federal government is a gigantic borrower, so inflation can represent a confiscation of wealth from the public.

It’s not small potatoes. Currently, about $22T of U.S. Treasury debt is held by the public, and its average maturity is more than 5 years. If the Federal Reserve engineers an unexpected 1% jump in the rate of inflation, it shaves over $1T off the real value of that debt before it’s repaid, and it reduces the real interest cost of that debt as well. Of course, the holders of that debt will suffer an immediate loss if they are forced to sell prior to maturity for any reason, since new buyers will be demanding higher yields to compensate for higher inflation if it is expected to persist.

The Poor Losers

Inflation causes redistributions to take place, especially when it is unexpected inflation. We’ve already discussed lenders and borrowers, but similar considerations apply to anyone entering into fixed price contracts for goods or labor. Here’s what Claudio Bario of the Bank of International Settlements (BIS) has to say about these shifts:

“Inflation shifts income and wealth away from those who are least aware of it, or least able to protect against it. These segments of the population often coincide with lower-income groups, which explains why inflation has often been portrayed as a most regressive form of tax. The ‘inflation tax’ takes its toll through the erosion of the value of financial assets and contracts fixed in nominal terms.”

Inflation is a regressive tax! In this respect, economist Noah Smith echos Bario in a recent op-ed in which he discusses “money illusion”, or the confusion of real and nominal income:

“Workers … who are slow to perceive the rise in prices they pay for goods like cars and groceries, won’t realize this, and will be happy with their unusually large raises. But companies, whose accountants and managers certainly know the true inflation rate, will also be happy, because they know they’re not actually paying more for labor.

That information asymmetry between workers and employers may be exactly what keeps wages from rising faster than inflation. If workers take a year to realize how much prices have gone up, they may be satisfied with the raises they got during the time of high inflation — even if that inflation ultimately turns out to be transitory. By then, it might be too late to negotiate for a real, inflation-adjusted raise.”

Inflation taxes and redistributions become more acute at higher rates of inflation, but any unexpected escalation in the rate of inflation will take a toll on the poor. Bario elaborates on the mechanisms by which inflation inflicts budgetary pain on the those at the lower end of the socioeconomic spectrum.

“As regards wealth distribution, the financial assets that are most vulnerable to inflation are cash and bank accounts – the typical savings vehicles held by the poorest segments of the population. This is mostly because the poorest have access only to limited investment options to protect their savings. …

… wages and pensions – the main sources of income for a large majority of households and even more so for the poorest half of the population – are typically fixed in nominal terms and hence vulnerable to inflation. Indexation mechanisms, such as those adopted in many [advanced economies] in the 1970s, are no panacea: they may fail to keep pace as inflation accelerates; …”

In addition to the inflationary gains reaped by government, it’s clear that inflation gives rise to redistributions between private parties: generally from those with lower incomes and wealth to their employers, producers, financial institutions, and pension payers (businesses, state and local governments). An exception is some low income debtors might benefit if they owe long term obligations at fixed interest rates, but low income individuals are often constrained from obtaining this form of credit.

Causing, Then Exploiting, Inequality

Another especially galling aspect of the Left’s focus on money finance is how its consequences fly in the face of their concerns about income and wealth inequality. Inflation is typically manifested in rising equity prices: nominal stock values tend to escalate in an inflationary environment, protecting their owners from losses to the real value of their investments. Stocks are generally a good inflation hedge. Yet we know that stocks are disproportionately owned by those in the highest strata of the income and wealth distributions. Later, of course, the Left will seek to level the burgeoning inequality wrought by their own policies by “taxing the rich”! Apparently, for the Left, consistency is never considered a virtue. This is not unlike another trick, which is to blame “greedy corporations” for the inflation wrought by Leftist policies.

It’s a great irony that the Left, which purports to support the poor and working people, would propose a form of government finance that is so regressive in its effects. To be generous, perhaps it’s just another case of “progressives” unknowingly hurting the ones they love. The expansive programs they advocate will confer government benefits to many individuals in higher income brackets, not just the poor, but those government alms will help to compensate for higher inflation. But this too takes advantage of money illusion, because those benefits might well buy progressives the loyalty of beneficiaries unable to recognize the ongoing erosion in their standard of living, and who are unwilling to come to grips with their increasing dependency.

But Tut, Tut, They Say

Advocates of MMT, in combination with expansive government, also have a tendency to deny that inflation has ever been a consequence of such policies. As Sumner points out, they have forgotten historical episodes that run contrary to the theory, and most “popular” advocates of MMT fail to recognize the important role played by limits on the economy’s production potential. When money growth outruns the economy’s ability to produce real goods and services, the prices of goods will rise.

The Dirt On the Corporate Income Tax

23 Tuesday Mar 2021

Posted by in Fiscal policy, Tax Incidence

≈ 2 Comments

Tags

, , , , , , , , , , , , , , , , , , ,

The Biden Administration is proposing a substantial increase in the corporate income tax rate from 21% to 28%. This is another case of a self-destructive policy that serves as a virtue signal to the progressive Left. See? We’re taxing the rich and their powerful corporations! What none of them realize is that the tax on corporate income is actually a regressive tax on consumers and workers; it is a disincentive to the formation of productive capital; and it is a highly wasteful tax due to compliance costs and the impact of avoidance. And the Biden proposal would make the U.S. less competitive internationally, as the chart above from Joseph Sullivan demonstrates. Maybe some of the proponents realize it, but they still like it because it sounds so good to their base!

It’s not as if all these unhealthy characteristics of the corporate tax are new findings. Milton Friedman explained some of the basics in 1971 when he said:

“The elementary fact is that ‘business’ does not and cannot pay taxes. Only people can pay taxes. Corporate officials may sign the check, but the money that they forward to Internal Revenue comes from the corporation’s employees, customers or stockholders. A corporation is a pure intermediary through which its employees, customers and stockholders cooperate for their mutual benefit.”

In 1984, two giants of public finance economics, Richard and Peggy Musgrave, investigated how the corporate tax was shifted to households. Here’s a description of their findings from a recent paper by Edward Lane and L. Randall Wray:

“… the bottom quintile pays 4.6–5.5 percent of its income toward the corporate profits tax, the top decile pays 2.5–3.7 percent of its income, and the ninth decile pays 2.4–2.9 percent of its income. They conclude that the corporate profits tax is largely regressive while the federal personal income tax is progressive.”

The incidence of the corporate tax rate falls primarily on workers in the form of lower wages and lost jobs, and on consumers in the form of higher prices. Lane and Wray cite several influential studies over the years showing a substantial negative association between corporate taxes and wages. As the authors note, major corporations often have pricing power in both product and labor markets, at least relative to their power in capital markets where they must raise capital. Capital markets are highly competitive, so they don’t provide much opportunity for shifting the burden of the tax to owners of equity and debt. There are limits on a firm’s ability to pass the tax along to customers and workers as well, of course, but shareholders are relatively well-insulated from the burden of the tax.

There are still other reasons to avoid increasing the corporate income tax rate. It currently raises about $200 billion annually for the U.S. Treasury, or about 7% of estimated federal tax revenue for the 2021 fiscal year. It also has extremely high compliance costs. Lane and Wray quote a 2016 Tax Foundation estimate that U.S. businesses face tax compliance costs on the order of $193 billion a year. Not all of that figure applies to corporations, and not all of it is for federal tax compliance, but a great deal of it is. There are also a number of ways the tax can be avoided, such as off-shoring operations and using overstated transfer prices of inputs obtained from units overseas. This is not an economically efficient way to generate tax revenue.

Moreover, the corporate income tax creates perverse incentives. When new investment in productive, physical capital is penalized at the margin, you can expect less capital investment, lower wages, and fewer jobs. Alan D. Viard explains that the dynamics of this mechanism take time to play out, but the longer-run decay in the capital stock is perhaps the most damaging aspect of a high corporate tax rate. And indeed, while there are probably short-run effects, the reduction in the incentive to invest is the real mechanism linking a higher corporate tax to reduced wages and higher prices, not to mention reduced economic growth.

Finally, there is a pernicious political-economic aspect of the corporate income tax owing to the difficulty for the general public in identifying its true incidence. This was also discussed by Milton Friedman:

“… Indirect effects make it difficult to know who ‘really’ pays any tax. But this difficulty is greatest for taxes levied on business. That fact is at one and the same time the chief political appeal of the corporation income tax, and its chief political defect. The politician can levy taxes, as it appears, on no one, yet obtain revenue. The result is political irresponsibility. Levying most taxes directly on individuals would make it far clearer who pays for government programs.

If the government intends to tax the owners of corporate wealth (a significant share of which is held in retirement savings accounts), it should be honest about doing so. That would mean taxing capital income in a more consolidated way, as Lane and Wray put it, at the individual level. That kind of transparency might be too much to hope for because the politics of doing so are much less favorable.

Meanwhile, the Biden Administration wants to have it all: higher corporate taxes and higher taxes on relatively high-earning individuals. But a significant burden of the corporate tax increase ultimately is shifted to individual workers and consumers. It is a regressive tax, and it is an inefficient tax with outrageously high compliance costs. It is a destructive tax because it undermines the economy’s growth in productive capacity. And it offers tax revenue to politicians who have little budgetary resolve, and with little political consequence.