Research Highlights

Tariffs or Tax? Policy Tools to Manage Globalization’s Impact

Michael Waugh

In no cases do we find that a tariff is welfare-improving. Rather, the optimal mix is a zero tariff and a more progressive tax system as the economy becomes more exposed to trade.

Debates about trade wars and tariffs compels a closer look at how to mitigate the pain that an increase in international trade imposes on the workers it directly affects. According to NYU Stern Professor Michael Waugh and PhD candidate Spencer Lyon, the solution lies in progressive taxation.

In “Redistributing the Gains from Trade through Progressive Taxation,” a working paper published by the National Bureau of Economic Research in June 2018, the authors observe that while trade is a net positive for the vast majority of the population, who enjoy the increased choice and lower prices it brings, it negatively affects certain workers, for example, those in manufacturing, steel, and medium-skill services.  They argue that the most efficient way to minimize their suffering – visible in their reduced earnings and employment opportunities – is through a progressive tax policy.

The authors acknowledge the underlying frictions in the economy that prevent more facile solutions for workers hurt by trade, such as rapidly relocating to the locations, sectors, or firms that are profiting from increased trade.  They also reject as problematic a transfer scheme that compensates losing workers for their losses while at the same time preserving some gains for those that trade helps. However, “We don’t think policy needs be silent,” says Professor Waugh. “We propose that increasing the progressivity of the tax system as the US becomes more open to trade helps transfer resources from the winners from trade to the losers.”

Progressive taxation is one way of evening after-tax income in a society lacking insurance markets, the authors assert. The key is finding the right balance between the costs of taxation and the benefits of the social insurance that a taxation scheme can provide. Too little social insurance risks unacceptable losses in wellbeing; too much erodes incentives and hence productivity.  The research suggests that US tax policy has been moving in the wrong direction given the trends in globalization.
“Trade is a labor-saving technology,” the authors conclude.  But tariffs aren’t the answer to any social imbalances it creates. “In no cases do we find that a tariff is welfare-improving. Rather, the optimal mix is a zero tariff and a more progressive tax system as the economy becomes more exposed to trade.”