Nobody enjoys paying taxes. Not even those of us who understand that taxes are the price we pay for a civilized society. But, structurally speaking, are some taxes worse than others? We can answer the question in the affirmative. One type of taxes takes the dishonor: Cascading taxes are the worst sort.
Cascading refers to situations in which a tax is not imposed on identifiable economic activity, but on another tax. That occurs when the government taxes you based on the existence of another tax that you (or someone else) already paid. Ponder that a moment and you’ll spot the circularity that makes cascading a cardinal sin among fiscal policymakers. It shouldn’t matter whether you’re a conservative, a progressive, or fall anywhere in between — cascading taxes are terrible economic policy.
Fortunately, we don’t see many real-life examples of cascading taxes. That’s because our lawmakers are typically wise enough to avoid them. Perhaps the best example of cascading is found in our subnational consumption taxes. Most U.S. states impose a retail sales tax. Ideally, those systems should exempt business inputs. They don’t. As a result, the sales tax burden on consumers is greater than it otherwise would be, irrespective of the sales tax rate. The sales tax we pay at the cash register includes a component that’s equivalent to a tax on a tax — the consumer is paying tax on the tax that the business paid for its inputs. (Side note: That’s why economists prefer VATs to retail sales taxes; VAT includes a mechanism that relieves the taxes paid on businesses inputs, preventing cascading.)
Tanks, Tariffs, and Trouble
Another example of a cascading tax recently popped up. As of January, the U.S. government is imposing tariffs on its own tariffs. That’s a regrettable development.
The Trump administration has been imposing controversial tariffs on steel and aluminum for several years. These tariffs are grounded in the notion that importation of these metals is a national security threat, as opposed to a purely economic threat. That’s authorized under section 232 of the Trade Expansion Act of 1962, which has rarely been invoked over the last half century.
The argument boils down to this: In the event of military conflict, America would benefit from a healthy industrial sector ready to produce equipment like tanks, missiles, and aircraft carriers — and we don’t want the Pentagon to be dependent on foreign suppliers. For the sake of argument, let’s accept the premise (even if most trade specialists are still aghast at the linkage).
Here’s the new twist: Early this year, the government broadened the reach of the section 232 tariffs with the specific goal of providing assistance to companies adversely affected by the earlier tariffs. When the price of imported metal increased, it forced many domestic companies into uncompetitive market positions. Their metal-intensive outputs became so expensive that nobody wanted to buy them. Production quality didn’t change; neither did labor costs. The only difference was that key inputs (imported steel and aluminum) became significantly pricier as a direct result of the tariffs. Affected businesses had little choice but to pass the increased costs on to consumers. Moreover, since the earlier rounds of tariffs applied to raw steel but not finished steel products, foreign competitors could often sell their finished products into the United States without paying the section 232 tariffs — which were baked into the sales price of many American manufacturers’ products. So much for a level playing field.
Some businesses warned the Trump administration that the tariffs were rapidly destroying their profitability and jeopardizing workers’ paychecks. The administration eventually responded by extending the scope of the section 232 tariffs to include so-called metal derivatives. Protectionism is being used as a remedy for economic damage resulting from, you guessed it, prior protectionism. Make no mistake, these are tariffs imposed on tariffs. It’s a cascading tax. Notably, it’s also an implicit acknowledgement that the trade wars are harming domestic industry.
The affected imports are narrowly targeted: steel nails, automobile bumpers, aluminum wires and cables, and body stamping for tractors. The nature of these goods makes the section 232 rationalization even more dubious than it was to start with. You’re not alone if you fail to see the connection between car bumpers and national security. Their ad hoc selection makes it look like the government is picking winners and losers in the marketplace in an undisciplined manner.
Warning: Infinite Loop
Let’s contemplate the bigger picture. It’s one thing to say American consumers should absorb higher retail prices when tariffs are necessary to teach the Chinese a lesson, punish them for past currency manipulation, or force them to stop stealing U.S.-developed technology. That’s all well and good. It is entirely possible for a person to be pro-tariff in the context of the U.S.-China trade relationship and anti-tariff in the context of our other trade relations. Larger geopolitical issues are at play when it comes to China. But these cascading tariffs also affect products from the EU, India, Japan, Oman, and Taiwan.
The problems with cascading tariffs go beyond the conventional arguments against protectionism. They suffer from a fundamental design flaw. What if this latest round of section 232 tariffs results in further distress to domestic companies? Should the government keep passing successive waves of compensatory tariffs to make up for the harm? Might we eventually have tariffs upon tariffs upon tariffs? It strikes me as pure folly to imagine that we can cure our tariff-induced wounds with additional tariffs. Once our trade policy goes down this road, how does the circularity end?
For those who’ve dabbled in software coding, the term “infinite loop” might come to mind. It’s not a comforting metaphor, but it seems to be where we are headed.