The Bear’s Lair: Balance the budget the McKinley way

Opponents of President Trump’s proposed tariffs obscure one important feature of them: they provide revenue for the Federal budget. President William McKinley financed the naval squadron that Admiral George Dewey sailed into Manila Bay to capture the Philippines entirely without an income tax. Looking at our budget today, he would be horrified by the trillion-dollar deficits but would point out that we had deliberately ignored several very substantial revenue sources, which could be used to alleviate the deficit problem. It is time we returned to McKinley-era budget policies, balancing both our tax system and the budget.

In McKinley’s era, both that of the McKinley tariff (1890) and his Presidency, Federal revenue was if anything excessive for the modest demands on the budget. The Congress of 1889-90, which raised tariffs through McKinley’s legislation, was known as the Billion-dollar Congress, because it was the first to spend that amount. However, its problem was not a budget deficit, but a surplus, which would grow larger as McKinley and the Republican Congress imposed a tariff more protectionist than the previous Democrat Grover Cleveland administration. Needless to say, that did not stay a problem for long. “God help the surplus” said James Tanner, head of the main Veterans association in 1889, and sure enough through larger veterans’ pensions the surplus was dissipated, producing a severe budget problem in the next downturn of the early 1890s.

The politicians of McKinley’s era found budget problems easy for two reasons. First, they did not have the huge overblown Federal government we have, with its ever-expanding programs and budget process that perpetually prevents us from eliminating any spending, however useless. This is our biggest problem; ever since left-wing Democrats “reformed” the budget process in 1974 spending has been out of control, with only the toughest, most committed Presidents such as Reagan and, surprisingly, Ford, able to rein it in a little, while weak sisters like the two Bushes are as profligate as any Democrat.

Our other problem, however, which McKinley would instantly spot, is that without tariffs the Federal tax base is too narrow. To get the revenue needed to run the Federal Leviathan, income taxes must be pushed to levels that are both politically unacceptable and economically disastrous. The British had the same problem, at a much lower level of government spending, during their free trade period after 1846. Lord Liverpool in Britain and McKinley in the U.S. knew that the necessary spending (in Liverpool’s case, including huge debt service after a major war) could be financed without doing too much damage, but that a substantial tariff was an essential component in doing this.

According to the latest Congressional Budget Office figures, the Federal budget deficit in the year to September 2020, without any recession having swollen it, will be $1,008 billion, or 4.6% of GDP of $22 trillion, with spending at 21.3% of GDP the main problem. That is unsustainable, especially as a recession must come sometime, and the baby boomers’ social security and Medicare costs are expected to continue increasing through at least 2030. Spending should be drastically reduced to balance the budget, but this is not going to happen anytime soon.

Tariffs, however, can make a big difference, because they flow into the federal government as revenue. This is the essential fallacy in the free trade thesis: free trade, especially unilateral free trade, increases trade, but at the cost of placing intolerable tax burdens on the domestic economy, especially domestic individual taxpayers, thereby weakening its competitiveness. Britain in the late nineteenth century, dissipating its industrial lead through unilateral free trade, is the classic example of what goes wrong.

U.S. imports will be around $250 billion per month in 2020, or $3 trillion in total. A low tariff of 10% on those imports, that figure being an average between zero on some imports and higher rates on others, will yield $300 billion annually (if imports decline because of the tariff, domestic production will correspondingly increase, raising tax revenues in other areas.) That’s 30% of the budget deficit covered, right there, at a tariff level that is very unlikely to damage world trade significantly. As I will shortly demonstrate, this is only one of the areas that have been unfairly exempted from tax; there will be more revenue to come. Still, solving even 30% of the problem is a good start.

Free traders claim that tariffs are universally bad for the economy. However, that does not appear to be true for the tariffs announced by Trump and his Chinese counterparts, which appear in combination to be highly beneficial to the United States. Trump’s tariffs target the tech sector, in particular areas where China has been stealing intellectual property. Reducing Chinese exports of these goods and increasing American companies’ global market share is clearly beneficial to the U.S.

China’s tariffs, on the other hand, target primarily U.S. agricultural commodities, presumably because China thinks the producers of these goods will exert the maximum political pressure on Trump and the Republicans. However, importing H2B visa or illegal immigrants at ultra-low wage rates and unpleasant working conditions in order to produce agricultural commodities that collect a subsidy from U.S. taxpayers before being exported at rock-bottom prices to China is utterly economically counterproductive in about six different ways – the welfare and social costs for the immigrants and their families, the subsidization of agriculture production and exports, you name it. So, the first round of proposed U.S. and Chinese tariffs are a win-win for the U.S., quite apart from the revenue for the Treasury.

Imposing tariffs fulfils one key economic criterion when seeking to raise government funds: it extends the tax base, imposing taxes on an area that had hitherto been free of them. Doing so balances the economy better, lowers the taxes that must be raised on other areas, and reduces economic distortions. Another area where taxes can usefully be raised is that of offshore intellectual property, such as patents and trademarks. Major companies have taken to hiding intellectual property in tax havens, where they can charge tax-free royalties, reducing their overall tax bill. This is pure scam, the Cayman Islanders have not invented anything or created anything; they are mostly either simple folk or tax lawyers.

Hence the U.S. should impose an excise on foreign-held intellectual property, charging say 25% of all royalty fees derived from intellectual property held outside the United States. This could usefully be extended to foreign companies, as well as U.S. companies. It would eliminate the pernicious practice of re-domiciling intellectual property, as well as encouraging worldwide multinationals to conduct their research and develop their IP in the United States. At a rough guess, that’s probably worth another $100 billion a year in tax revenue, but that covers another 10% of the deficit, with highly beneficial side-effects for the U.S. economy.

The final area of zero-tax activity that could be taxed, again with highly beneficial effects on the U.S. economy, is that of charities. The charitable tax deduction on individual income alone costs $60 billion annually, or probably $70 billion by 2020, while overall charitable exemptions, including their exemption from tax on their own activities, will cost around $200 billion in that year. Taxing charities like everybody else, therefore, will yield another 20% of the funds required to close the budget deficit. It will also close the most egregious tax loophole, used primarily by the very rich, not by anyone who could be described as “middle class” on any definition of that term.

Taxing charities would have a huge beneficial effect, both on the U.S. economy and on U.S. life in general. Since the charitable tax deduction is of use primarily to the very wealthy, what counts as “charity” is left to the ethical standards of their tax lawyers, which are about as you would expect them to be. Consequently, not only are many of the deductions phony, such as deducting artworks at an altogether spurious inflated “valuation,” but the charities themselves include left-wing propaganda outfits as well as outright scams (Clinton Foundation, anyone?)

Even genuine charities conduct their activities with a disregard to the market and an attention on public relations and fundraising that makes the genuine good they do a vanishingly small proportion of the funds raised. If even the genuine charities are laughably inefficient economic entities, often doing as much harm as good, and the political agitators and outright scams are a substantial proportion of the whole, then the entire sector, representing close to 10% of GDP is a huge drag on the U.S. economy. Removing charities’ tax privileges will do enormous good, both economic and non-economic, as well as raising very substantial revenues.

By extending the tax system to these three areas of unjustified tax exemption, foreign trade, intellectual property and charities, we have closed around $600 billion of the $1 trillion 2020 budget deficit. You can add another $20 billion from eliminating agriculture subsidies. Hard work will still be needed in reducing expenditure, so Congress cannot abandon its feeble efforts in that direction. Still, accomplishing 60% the deficit closing objective is well worth doing, and we will in addition have improved the performance of the economy by doing so, perhaps producing an additional tax revenue fillip. President McKinley would be proud of us!

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)