Instead of tariffs, just subsidize stuff

Subsidies lay bare the real winners of a policy

Politicians love to slap tariffs on things. It’s a great way to show your constituents that you’re “tough on China” or how much you care about local widget manufacturers. Local widget manufacturers love it too, it’s basically free money; the taxes increase price of foreign widgets, increasing demand for locally produced widgets.

Who else benefits from the widget tariff? Basically no one. The foreign widget manufacturers lose profit, local consumers pay higher prices, and the deadweight loss of taxation curbs growth for everyone. Not to mention the follow-on damage from supply chain shocks and retaliatory tariffs.

But what can you do? Politicians and interest groups play a million petty, negative-sum games, tariffs aren’t even their worst offense.

I just have an awkward question for them: if they’re so excited about giving interest groups money, why not just provide a subsidy? The effect is roughly the same, all the taxpayers in the country get a little bit poorer in order to make manufacturers richer. Subsidies might even be more efficient overall since the funds are collected via relatively-more-efficient taxes instead of a capricious tariff. A subsidy also has a better chance of avoiding retaliation¹.

So why don’t politicians do this instead? Because it looks bad. A subsidy lays bare the crony politics happening behind the scenes. Tariffs provide cover, it intuitively looks like the tax falls on foreign producers. But the real losers are a diffuse set of consumers and businesses that rely on the foreign product. It’s hard for them to coordinate to repeal the tariff.

Because tariffs provide a cover for local industries to get an unfair advantage, I think our political system would be better if politicians didn’t have the power to put tariffs on things in general.

There are legitimate reasons to tax imports, but most of those reasons are better served by subsidies. If an industry is important for national defense, the government should aggressively fund new facilities within their borders. That’s exactly what the U.S. is doing with semiconductor manufacturing for example. If another nation is dumping cheap goods to weaken domestic industry, subsidize local producers to help them weather the shock.

Subsidies not only have slightly higher tax efficiency, they’re also far more transparent. It’s clear who the money is going to and why, voters don’t need a degree in economics to see who gains from the policy. The costs are borne on taxpayers instead of a convoluted set of producers and consumers that is unique to each tax.

I think that in practice, taking tariffs off the table will lead to less crony politics. When congressmen can’t hide behind the complexities of tax incidence, voters will punish them for subsidizing small industries at everyone else’s expense.

This points to a general principle for policy: if the government can achieve the same goal by spending money or by taxing something, it’s better to take away the option to tax and use subsidies instead. Like we discussed, subsidies are far more transparent than taxes, leading to less bad decisionmaking overall. Coupled with an efficient tax system, subsidies can be much more economically efficient.

This principle can apply more broadly, not just to tariffs but to taxes and certain forms of regulation. For example:

• Occupational licensing creates a barrier to entry to a particular profession, from doctors to hairdressers. This lowers the supply of labor and increases wages, at a cost to everyone else. Instead of banning unlicensed work, give people who complete the license a big chunk of cash, equal in size to the money they would have made under an occupational licensing environment.

• Governor DeSantis recently banned cultured meat in the state of Florida. But he could have achieved a similar effect by subsidizing meat producers enough to price out cultured meat.

• Instead of creating weird tax loopholes and exemptions, give people money. This keeps the tax code much simpler and makes it harder to manipulate.

• Virtually every industry has some form of regulation on how goods can be produced. Instead of requiring certain practices, simply subsidize companies that comply. By raising the subsidy high enough, they will drive noncompliant companies out of existence.

This trick works pretty much any time the winners are a concentrated, identifiable group while the losers are very diffuse². Though there’s a better way to impose these kinds of regulation, subsidies are still an improvement over outright bans³.

Of course, politicians will never go for a rule that takes away their power to enact capricious taxes and enrich their allies for political gain⁴. Instead, this change has to happen at the constitutional level. The result would be less crony politics, increased growth, and far more transparency about the effects of government policies.

1. The subsidies are still bad. They still have an associated deadweight loss, create supply chain shocks, and risk retaliation.

2. Notice that the losers in a lot of these examples are the set of consumers in the economy. By using a subsidy the losers become the set of taxpayers. Because of the substantial overlap between consumers and taxpayers this change doesn’t make a huge difference. Because more taxes are paid by wealthier individuals, a subsidy is actually more progressive than a tariff.

3. In fact, governments can subsidize participation in regulated marketplaces.

4. To temper my cynicism somewhat, politicians and interest groups are just following their incentives. Elected officials have to balance between the needs of their constituents, their convictions, and the chance of reelection. Giving a boost to local industries at the expense of growth is just how the game is played. All the more reason to take that option away so that politicians can focus on better ways to get reelected.