coin of the other country. There is no fixed par of exchange between
gold-using and silver-using countries: par of exchange between them
fluctuates with changes in the comparative values of the two metals.
The _gold shipping points_ for importing or exporting gold are
respectively par of exchange plus or minus the cost of moving the
actual metal. These points vary with means of transportation and
communication. The par of exchange between New York and London being
nearly $4.866 and the cost of expressing and insuring a gold pound
between New York and London being approximately $.02,[9] the shipping
point for the export of gold from New York is $4.886 and for the
import of gold to New York is $4.846. At these upper and lower limits,
there is a motive for shipping gold as a commodity.

When large sales have been made to Europe and credits are accumulating
in New York and the importation of gold is imminent or already begun,
the claims are bought by bankers in New York at less than par. At such
a time one needing to remit a sum to London can buy exchange for less
than par, for every such draft remitted reduces London's indebtedness
and, by so much, the need of shipping gold to this country. As a
rule then, accumulating credits here mean a low rate of exchange,
accumulating debits a high rate of exchange from this to the foreign
country.

These are the merest rudiments of the subject. The many problems
arising, such as the adjustment of foreign credits to changing needs,
and such as arbitrage (the readjustment of the rates of exchange
prevailing among different financial centers) make foreign exchange
both a complex science and a difficult art.

§ 10. #International monetary balance and price-levels.# The balance
of all accounts for or against a country (including new loans, current
interest, and repayments) must thus eventually be settled in money.
This cannot fail to affect the general level of prices in both
countries, tho this is brought about often only in indirect and
gradual ways. The flow of money out of a country causes the loan
market of a country to tighten (interest and discount rates to rise)
in proportion as the reserves of the banks are reduced. Then "general
prices" begin to fall.[10] When prices fall, imports decline, as the
country is not so good a place in which to sell: when prices rise,
imports increase, as it is a better place in which to sell. The
opposite effect is produced on exports, and thus in a short time the
national credits and debits are again brought into equilibrium. A
slight movement of money in either direction is enough to influence
prices and set in motion forces to counteract a further flow of
money. Decade after decade the circulating medium of leading countries
changes very slightly in amount, and the fluctuations in its amounts
during periods of so-called "favorable balance of trade" and of
"unfavorable balance of trade" are only the smallest fraction of the
value of goods passing through the ports of the country.

It is therefore absurd to imagine, as is sometimes done, that a
country could, by continually importing goods, be drained of all its
money, or that by any possible set of devices it could forever have an
excess of exports to be paid for by a continual inflow of gold.
Long before either of such movements could go far, the automatic
readjustment of prices would inevitably check it, and secure and
retain for each country its due portion of the money.

[Footnote 1: See Vol. I, ch. 17, sec. 10.]

[Footnote 2: See Vol. I, ch. 5, secs. 1 and 7.]

[Footnote 3: See Vol. I, ch. 6, sec. 11, on the origin of markets.]

[Footnote 4: See Vol. I, chs. 36 and 37.]

[Footnote 5: Recall ch. 4, in general, on the nature of monetary
demand.]

[Footnote 6: See Vol. 1 for numerous statements of the effects of
varying quantities of agents upon the economy of utilization; e.g.,
pp. 138, 163, 164, 213, 228, and chs. 34 and 35 entire.]

[Footnote 7: This theory has usually been presented under the name
of "the doctrine of comparative costs." The word "costs" is very
misleading in this connection because it is now always applied to
enterpriser's outlay. It seems best, therefore, to replace it in this
phrase by the word "advantages." Of course, it _never_ can be true
that an article can be "profitably" imported when its monetary costs
(all things considered) are higher in the exporting than in the
importing country. Indeed, the importation of any article is proof
conclusive that the importer thinks that the monetary costs of
an article would be higher in the importing than in the exporting
country. See further, ch. 15, secs. 11 and 13 (note).]

[Footnote 8: See ch. 7, sec. 7.]

[Footnote 9: This varies also with conditions; after the outbreak of
the war in 1914 it was for a time as high as $.05 because of high war
rates of insurance.]

[Footnote 10: The connection between a high rate of interest and
falling price is a dynamic phenomenon of a very temporary nature.
In long-time static conditions the general level of prices and the
prevailing rate of interest are dependent on entirely different sets
of forces. See on the theory of interest, Vol. I, p. 308. In long-time
movements of prices, in contrast with brief changes due to foreign
trade such as are referred to above, high rates of interest are
connected with rising prices, and _vice versa._ See above, ch. 6, sec.
8, on fluctuating price-levels and the interest rate.]

CHAPTER 14

THE POLICY OF A PROTECTIVE TARIFF

  § 1. Military and political motives for interference with trade. § 2.
  Revenue and protective tariffs. § 3. Growth of a protective system.
  § 4. The infant-industry argument. § 5. The home-market argument.
  § 6. The "two-profits" argument. § 7. The balance-of-trade argument.
  § 8. The claim that protection raises wages. § 9. Tariffs and
  unemployment. § 10. Exports and exhaustion of the soil. § 11. Protection
  as a monopoly measure. § 12. Harm of sudden tariff reductions.

§ 1. #Military and political motives for interference with trade.#
The considerations set forth in the last chapter raise a strong
presumption in favor of the sovereign state permitting its citizens to
trade freely across its boundaries, as the best way to further their
own prosperity and, on the whole and in the long run, that of the
nation. Indeed, this presumption and belief has been held by
nearly all serious students of the question, with more or less of
modifications and qualifications, ever since Adam Smith published his
work on the "Wealth of Nations" in 1776.[1] But in conflict with this
belief has been the all but unanimous policy of nations from
early times, throughout the Middle Ages, and down to this day, of
interposing some special hindrances (of varying degrees and kinds) to
this kind of trade. Sometimes this has been done by prohibitions, but
more often by taxes imposed upon either imports or exports. Sometimes
the attempt is made to justify the policy of governmental interference
with foreign trade by arguments which crumble before the slightest
examination, and again it is admitted that free trade is true in
theory, but it is declared to be false in practice. The latter view
is not to be entertained for a moment. If free trade in theory (as an
explanation) is complete and true, it will in practice (as a plan of
action) be sound and workable. In truth, however, the practical policy
of governmental interference with foreign trade has always in part
rested on other than the simple economic grounds.

Interference with free trade with the foreigner has always been in
large measure due to political motives. In every petty medieval state
or self-governing city, the aim was to make the economic boundaries
coincide as nearly as possible with the political boundaries. Except
for the trade in a few articles of comparative luxury this aim was
at that time nearly attainable. The peasantry surrounding a fortified
town and enjoying its protection were compelled to trade there. Down
to our own time it has seemed to statesmen expedient to forbid or
discourage trade that might nourish the economic power of future
enemies. Sometimes governments have used embargoes, bounties, or
tariffs as weapons to injure the trade of other nations and to secure
diplomatic or commercial concessions. Often they have sought by
tariffs to encourage the building of ships and the manufacture of
armaments and of all kinds of munitions by private enterprise within
their own borders, even when the immediate cost of these products was
greater than if they were purchased abroad. In such cases it is
always a question whether an outright expenditure would not be better,
whether the government could not build its own arsenals and shipyards
more economically than it can foster private enterprise by means of a
protective tariff. However, the political (or military) argument for
protection recognizes that it is in itself a costly (not a profitable)
policy, and that the cost is only justified on the grounds that
military necessity warrants the outlay.

The military argument as applied to the preparation of ships and
munitions has no application to a tariff on those articles which have
no bearing upon military power. But the most recent application of
science and the mechanical arts to the uses of war has given new
significance to a larger policy of industrial preparedness for
military purposes. The year 1914 doubtless ushered in for the world
a new epoch of protective and discriminatory tariff legislation
determined by political rather than by direct economic considerations.

§ 2. #Revenue and protective tariffs.# An important distinction in
principle is to be made between a tariff for revenue and a tariff
for protection. A _revenue tariff_ is a schedule of duties on goods
entering or leaving a country, so arranged that the collection of
taxes causes the least possible disturbance to domestic industry.
Speaking generally, the duties may be on either imports or exports;
but, as export duties are unconstitutional in the United States, our
tariff discussions are concerned only with import duties. The most
completely revenue-yielding tariff is one touching only articles
which, even at the higher prices are not in the least to be produced
profitably in the home country. A _protective tariff_ is a schedule of
import duties so arranged as to give appreciably higher prices to some
domestic enterprises than they could obtain with free trade. It shuts
out some foreign goods which would otherwise enter, an in so far it
"protects" the domestic producer from the foreign competitors who
would sell at lower prices than those at which he can or will sell.
In other words, "protection" means governmental interference with the
freedom of trade.

The distinction between revenue and protective tariffs, thus clear in
principle, is not always easy to make in practice. It does not lie in
the intention of the taxing power, but in the actual effects produced.
Most tariffs combine the characteristics both of revenue and of
protective measures. A tariff that reduces imports but does not
cut them off entirely may be called either a revenue tariff with
incidental protection or a protective tariff with incidental revenue.
The difference is one of degree. But notice particularly that the two
features of protection and of revenue are mutually exclusive. To the
extent that one is present the other is impossible. A tariff rate
that in whole or in part excludes the foreign article to that
extent affords "protection" but does not yield revenue. Whenever the
government collects a cent of tariff taxes, the domestic producer in
so far and as respects that unit of goods is unprotected. Likewise,
whenever any domestic producer enjoys "protection" in respect to any
unit of goods, importation is in so far prohibited and the government
is deprived of any revenue whatever derived from the production and
sale of that unit of goods.

§ 3. #Growth of a protective system.# The protective policy developed
at first accidentally, as it were, out of the practice of levying
taxes for revenue only. Tolls, dues (or duties), customs (that is, in
former times the customary dues paid by merchants, now the dues fixed
by law), tariffs (that is, schedules or lists of rates of duties) were
at first intended to raise revenues for the sovereign, the city, or
the state. The unintended, and to some degree inevitable, result of
the taxation of goods in commerce, whether imports or exports, is
to prevent and discourage trade and to raise the prices of the goods
imported. Any change in tariff duties, therefore, at once alters
the previously existing adjustment of profits and of industries in a
country.

The first effect of the tariff is the same as that of any new factor
in enterpriser's cost; the same, for example, as that of a new
domestic tax on an article or as that of a rise of freight rates--the
domestic price of the taxed article tends to rise. Other results then
follow. If the article cannot, even at the higher price, be produced
within the country (as in the cases of oranges, spices, and coffee
in England, Norway, and Sweden), its consumption is reduced. The
lessening of demand may, however, depress somewhat the price in
the producing country. But as such a tariff does not increase home
production of the taxed article, it is therefore for revenue, not for
protection.

But if the article can be profitably produced in the importing
country at the new price, "home industries" will start. Where the
transportation charges are low, as on the coasts and on the main lines
of railways, some imported goods may be bought, while farther inland
where transportation charges are higher home production of some or all
grades of such goods may take place. If the whole demand at home is
supplied and all imports stop, therewith cease all revenues to
the government from that source. A completely protective tariff is
completely prohibitive.

Experience abundantly shows that, with a few exceptions, due to
climate and natural resources, it is impossible to put into effect the
most moderate schedule of duties without the increase in price at once
causing some men to shift their occupations, and to begin producing
articles of the kinds that have risen in price. At once appears a
group of "protected industries," the owners of which are dependent for
the safety and profits of their investments, and the workmen in which
are dependent for the security of their present jobs (possibly for
the chance to continue the pursuit of highly skilled trades) on the
continuance, if not the increase, of the existing tariff rates. A
tariff may be adopted mainly from stress of financial need (as in our
own history in 1789 or in 1861), but its modification or repeal cannot
be decided by fiscal considerations. The "incidental protection" it
affords has created a wealthy and influential group of employers and a
large body of employees who are irresistibly tempted to exercise their
influence in politics almost solely in favor of continuing and of
increasing the rates to the sacrifice of the higher civic life of
their communities. Of course the beneficiaries of the tariff usually
believe sincerely that it is indispensable for the prosperity of the
country as a whole, and they can do much to persuade others to
the same opinion. This commercial motive for maintaining existing
protective tariffs explains in large part their wide prevalence,
whatever other reasons may be adduced in their justification.

§ 4. #The infant-industry argument.# Most free-trade writers concede a
limited validity to the claim that protection may be used to encourage
infant industries and thus diversify the industries of the country. If
the natural resources of a land are adapted to an industry, it may be
called into being earlier by a fostering protective tariff. This is
merely anticipating and hastening the natural order of progress. In
the American colonies the manufactures of such goods as iron, cloth,
hats, ships, and furniture sprang up and continued not only without
"protection," but despite numerous harassing trade restrictions made
in the interest of English merchants. Can it be doubted that many
of these industries would have developed and flourished after the
adoption of the Constitution with no other favoring influences than
those of rich resources and of economy in freights? In the Mississippi
Valley since 1880 natural gas, abundant coal, ore, and timber have
made possible a great growth of industries without protection against
the Eastern states. Industries capable of eventual self-support must
in most cases naturally appear in due time. Economic forces will bring
them out. The protective system has often been likened to a hothouse,
anticipating the season by a few weeks and at great cost. The question
is whether the mere possession of the hothouse is a luxury worth the
price, if meantime the products can be got more cheaply by trade.
English manufactures flourished in the nineteenth century because they
were well established, had excellent coal supplies, great stores of
iron ore, and low-paid labor which did not have the opportunity of
better alternatives, as did the American workman. If America had
imported more (it would not have been all) of her iron and coal, the
English mines would have begun to shown signs of exhaustion earlier,
and America's advantage surely would have asserted itself in time. Her
iron manufactures undoubtedly were hastened--they cannot truly be said
to have been created--by the protective tariff.

The peculiar advantages of a new country attract labor and
enterprise into a few lines. Industries are forced into an earlier
diversification by tariffs. Which is the better economic situation?
Contrast Iowa, Dakota, and Minnesota, or Kansas, if you please, with
New York and Pennsylvania. Is it so certain that a dense population
congested in cities and crowded in factories and mines is a more ideal
social aggregation than is a community of prosperous farmers? The
smoky industrialism fostered by protection often puts a premium on a
low grade of immigrants, crowds then into city slums and into forlorn
mill towns, and keeps them aliens to the American spirit. It would be
surprising if Americanism on the Western plains were not as sound
as in the crowded cities. But the infant-industry argument appeals
strongly to the enterprise and the speculative spirit of Americans,
who like to do all things rapidly and on a large scale. Every village
aspires to be a great industrial center. Americans are impatient of
the suggestion that things "will come in time"; they like things to
come at once.

It must, however, be recognized that in a new country there is often
a certain monotony and poverty of life because of the lack of
diversified industries. There are not sufficiently varied avenues for
the expression and use of the manifold talents of the nation. There
are unused materials and opportunities, but the initial expense of
experimentation, the initial difficulties of gathering and training a
working force, are discouraging to individual enterprise, prices being
as they are. A protective tariff is not necessarily and always the
best way, but it is one way of helping private enterprise to establish
and conduct such industries through their initial period. But as has
been pointed out by many writers, the infant-industry argument is
self-limiting, and involves always the assumption that the industries
selected as fit for protection are such as ultimately, and within a
moderately short period, can grow into self-dependence. The infant
must sometime grow to be a man and stand on his own legs, or he is
either a chronic invalid or a degenerate.

#§ 5. The home-market argument.# The home-market argument seeks to
show a more permanent need for a tariff. At the same time it appeals
to the farmers, whom it has been hard to reconcile to a policy which
in America[2] has been peculiarly favorable to manufacturers. The
home-market argument extols the advantages of having near to the
farms customers for agricultural products, and dwells on the greater
steadiness of domestic trade. War or political changes, it is said,
may change the demand for products. This is true, but no other changes
have affected American agriculture so radically as the peaceful
development of domestic transportation and the opening of the West.

The main economic claim made in the home-market argument is that the
shipping of food to Europe and the importing of manufactures involve
a great cost for double freights which could be saved by manufacturing
at home. The farmer is supposed to pay this cost. The obvious defects
in this view are: first, there is nothing to show that the freight is
not partly or entirely paid by the European, either the manufacturer
or the food consumer; secondly, home trade "saves the freights" for
the farmer only in case he can buy goods under a tariff with less
of his own labor and products than under free trade. The payment of
freight charges is true economy when the goods can be bought at a
distance on more favorable terms than near home. The freight argument
attempts to prove too much for it condemns every trade within the
country, of goods produced a stone's throw away from the consumer.

The home-market appeal is strongest when addressed not to all farmers,
but to one class of farmers, those whose lands are situated nearer the
manufacturing cities. As city population grows, some land is converted
from the extensive cultivation of corn and wheat to dairying, fruit-
and market-gardening in the neighborhood of cities, and perhaps at
length is used for factory sites or as city lots. There is, thus, a
partial validity in the argument as applied to a comparatively small
number of farmers, who gain as landlords, not as tillers of the soil.
Even greater gains have sometimes been reaped by the owners of timber
lands, ore mines, coal lands, and other natural resources, the values
of which have been raised by tariff legislation. But unless these
gains come from truly productive additions due to the tariff, there is
no benefit to the community as a whole.

#§ 6. The "two-profits" argument.# Somewhat related to this idea of
the saving of two freights is the "two-profits" argument. It is said
that the tariff keeps "two profits" at home, foreign trade gives but
one. The word "profits" is here used in the popular sense of gain from
a single transaction. Both parties are said to profit and both profits
are thought to be secured at home when two citizens are forced to
trade with each other. The view that there are "two profits" in a
trade is an advance upon the notion that "one man's gain is another's
loss,"[3] but there is an error in elementary arithmetic here, both as
to the number and as to the aggregate amount of profits. The purpose
of a protective tariff is to compel two of the citizens of a country
to trade with each other instead of trading with two citizens of a
foreign state; the number of profits made by each country is therefore
not increased by substituting domestic for foreign trade.

What, then, as to individual size and aggregate amount of the profits?
The gain is not the same in all trades; the trade is made if there
is a gain to each party, no matter how small it is; but the generous
"profit" on one transaction where the conditions of the two parties
are very different may be greater than the total of petty gains on a
dozen trades between two traders of evenly matched powers. Indeed,
the greater the difference in the conditions and the capacities of two
groups of traders, the greater is the sum of the profits which they
may secure through the members of each group trading with those of
the other, rather than by the members of each group trading only among
themselves. Can it safely be assumed that every trade with a foreigner
is less advantageous than one with a fellow-citizen? Diamond cuts
diamond, but two Yankees left to themselves surely should not be
worsted in bargains with the universe. If they could exchange to
better advantage with each other they probably would discover it as
soon as the interested manufacturers and political orators who can
prove so eloquently that they know the other man's business better
than he knows it himself. Forcing the home trade by making our
citizens trade with each other whether both wish to or not may be
to the advantage of one citizen, but it is not likely to be to the
advantage of both citizens.

§ 7. #The balance-of-trade argument.# At the foundation of nearly
all belief in the virtues of a protective tariff will be found the
"favorable balance-of-trade" notion. The ideal of the more thorogoing
upholders of a protective policy is to keep merchandise consistently
flowing out of the country, and to have nothing come in--in any case,
nothing that by any fair amount of effort (whatever that be) could be
produced at home. This is called maintaining a "favorable balance of
trade." Sometimes the emphasis is more on the advantages of an excess
of exports of goods, sometimes more on the importance of the need "to
keep money at home." The simple error in these opinions is clearly
apparent in the explanation of foreign exchanges and of the principles
regulating the international flow of money.[4]

An interesting commentary on the opinion before us is the fact already
noted[5] that an excess of exports is the usual situation in poor
debtor countries having constant interest payments to meet; while, on
the contrary, rich creditor countries have an excess of merchandise
imports.

The "favorable balance-of-trade" argument, with the emphasis on money
rather than on goods, is that the protective tariff keeps money at
home which, if trade is free, will be sent abroad to buy foreign
goods, thus impoverishing the country. This doctrine as presented
in the seventeenth and eighteenth centuries in Europe, was known as
_mercantilism_. It had great influence upon the commercial policies
of all the great European nations. A superficial glance at the trade
relations of an old, rich country with a new province seems to give
evidence for such a belief. A richer country that is lending capital
(sent to the debtor country in the form of goods) has at the same time
a larger supply of money. The lack of money and the poverty of the
newer country are looked upon by the protectionist as due to the
importation of goods. The common cause of the imports to newly settled
districts and of their scanty stocks of money, it need hardly be
repeated here, is the comparative poverty of settlers and pioneers.[6]
Often these are paying for imports by means of loans, and in any case
their monetary stocks are not decreased either by their foreign trade
or by their domestic trade with the older and richer parts of the same
country. Europe and the United States, in their trade with China and
South America, usually do not get gold in exchange, but merchandise
of various sorts. It is true that in the trade of England and New York
with great gold-producing districts, such as California, South Africa,
and Alaska, gold is received in return for merchandise, for much of
the gold in gold-producing districts is merely merchandise, and its
export does not drain them of their due portion of money. There was
a time when the states of Kansas, Nebraska, Iowa, and their neighbors
were filled with resentment against the money-lenders of the Eastern
states. There was a widespread belief that hard times were due to an
insufficient currency.[7]

Attempted action took the form of the greenback and free silver
movements, which were defeated by the opposition of the East, but
there can be little doubt that if the Federal Constitution had
not forbidden it, the discontented states would have established a
protective tariff "to keep their money at home." Few advocates of
protective tariffs are ready to admit that the money stock of the
country is dependent on the general wealth of the country and on the
methods of doing business, rather than on a protective tariff.

§ 8. #The claim that protection raises wages.# The most effective
popular claim made for protection is that it raises, or maintains, the
general scale of wages in the country. This argument takes two forms:
first, when wages are low in a country it is claimed that a tariff is
needed to raise them; and, secondly, when wages are high it is argued
that a tariff alone can preserve them. In Germany the fear is of the
higher paid and more efficient labor of England. In America, where
general wages at all times have been higher than in England, it was
first argued (in the time of Henry Clay) that because of the greater
cost of production, due to high wages, the tariff was needed to start
certain industries; but after the tariff had long been established
and the old argument had been forgotten (ever since 1865), it has
been urged that the tariff, being the cause of high wages, must
be maintained to protect against the "pauper" labor of the older
countries. The higher wages in new countries where a tariff exists are
always claimed to be the fruits of a protective policy. The true
cause of the high general scale of wages in America is the greater
efficiency of industry under existing conditions.[8] Labor is
surrounded here with advantages in the forms of rich natural resources
and of mechanical appliances such as never before were combined.
Because of the scarcity of workers in particular protected industries,
wages may be temporarily higher in them than in some other industries;
but such workers form a small fraction of the population, and it is
impossible to show that the general scale of wages in all occupations
is raised by the tariff protecting this fraction.

There is, of course, no question that every tariff change affects
certain enterprises and classes of workmen. Enterprisers already
acquainted with and engaged in a business always may hope to gain by
the higher prices immediately following a rise in the tariff rates
on their particular products. Though they are granted no enduring
monopoly by the protection, they for a time enjoy the advantage of
being on the ground, and may reap the first fruits of the favoring
conditions. The enterpriser usually profits when the price of his
product suddenly rises. Usually skilled workmen are affected slowly by
competition when there is any considerable increase of prices in their
special industries. The important question is, Who bears the burden of
the higher prices that result from a tariff? The burden is very soon
distributed. A part of it may be for a short time borne by the retail
merchants, but ultimately nearly the whole of it must be borne by
their customers, the unfortunate, less favored citizens. The weight
falling on each is usually small, often unsuspected, always hard to
measure. The increased benefit is concentrated in a few industries and
accrues to a comparatively few producers. Here is a recipe for riches:
get everybody to give you a penny; it's so little that no one will
miss it, and it will mean a great deal to you. Something like this
happens in the case of many protected industries; every consumer
of the article pays a few cents more, a small group of wage-earners
temporarily gains, and a few enterprises wax wealthy.

§ 9. #Tariffs and unemployment#. The claim that a low tariff is bad
for the workers is made with peculiar success in any period when
unemployment is greater than usual. It is vain in reply to show that
again and again equally bad periods of unemployment have occurred when
a high tariff was in force, and that often the most highly protected
industries are most affected. It is vain to suggest that fluctuations
of unemployment are related rather to the rhythm of industrial cycles
and panics, than to any particular level of the tariff, whatever it
be.[9] The fact that at the moment is seen is that here are some men
for the time out of work, and here are some foreign goods coming in.
Of course, what is not seen is that if we stop importing goods we
thereby eventually will stop the exportation of goods of equal value
now being sent in payment and this must throw as many men out of jobs
as we helped into jobs by raising the tariff. But the view easy to
take is the short view, and the ulterior consequences seem to the
popular mind to be vain imaginings.

§ 10. #Exports and exhaustion of the soil#. It has been ingeniously
argued that a tariff may keep some of the natural agricultural
resources of a new country from becoming quickly exhausted. The export
of food takes out of the soil and out of the country fertile qualities
never to be returned. The shipment of several hundred million dollars
of food products year after year represented a tremendous drain from
the soil of the United States, but this has now largely ceased.
The assumption, however, that the use of the food in this country
preserves the fertility of our own fields is in the main mistaken. The
fertile material in the food for human consumption hauled to a town
five miles away from the field is almost as entirely lost as if it
were shipped to Europe. Engineering skill has as yet succeeded in
returning economically to the fields from which it comes hardly a
fraction as much fertile organic matter as that which flows into the
sewers, that is dumped into river and ocean, and that is buried in
heaps at the borders of our own cities. Artificial fertilizers are
increasingly used, to be sure, but they are obtained in other ways.
On the other hand, the increased use of iron, coal, and timber, as a
result of encouraging manufacturers, has very effectually hastened the
exhaustion of the natural resources of the country.

§ 11. #Protection as a monopoly measure#. It has rightly been observed
that a new country has a limited potential monopoly in certain kinds
of products and that a tariff may make it effective. The rapid opening
up of America with its rich natural resources greatly benefited
the average consumer in Western Europe, altho it caused a loss to a
special class of landowners.[10] Whether the citizens of the older
or of the newer country shall reap the greater benefit in the trade
depends on the reciprocal demand for the two classes of goods, as was
seen in discussing the equation of international demand. A wide margin
of advantage may go to one party and a narrow margin to the citizen
of the more favored land. To put it concretely: America, having great
natural resources for agriculture, might continue to trade food for
manufactured goods even tho England reaped most of the benefits of the
trade. An American tariff on manufactures from England would, under
such conditions, check the demand for English products and compel some
Americans to leave farming. This reduction of the American supply
of wheat or corn and of the American demand for English manufactures
compels a new ratio of trade (expressed in prices). It is conceivable
that trading fewer goods with a larger gain on each trade would give
a larger total of gain to the favored nation. Thus, foreigners may
conceivably be compelled to pay a part of the tariff duties to
enjoy the favored market. This is but a special case of the monopoly
principle; the government by law artificially limits the supply of
goods offered by its citizens.

This argument is somewhat subtle, but probably is the soundest one in
the theory of protection. The supposed conditions seldom occur in
a marked measure, but they may exist, and probably have existed
in America. When the great system of internal transportation was
developed in the United States before that of the other new countries
(say from 1840 to 1894), this country had such peculiar advantages for
the production of food that the quantity was enormously increased
and agricultural prices fell.[11] At such a time the tariff may have
worked toward checking the fall and earlier reestablishing a more
favorable ratio. It did this by making prices of manufactured goods in
this country artificially higher and thus tempting men from rural to
urban callings. But the limited application of the principle must be
recognized. The potential competition of undeveloped countries on all
sides, seeking to develop their resources, and profiting by the higher
prices of food in the world-market caused by our tariff, threatens
the peculiar advantages of the favored land. Russia, Argentina, and
Australia have rapidly taken the place of America in supplying food to
Western Europe, in part, no doubt, because we refused to take Europe's
goods in trade. A great nation with its manifold interests is not
eminently fitted to practise the gentle art of monopoly.

The period in America from about 1840 to 1890 shows certain absurd
contradictions in economic policy. By governmental action, national,
state, and municipal, enormous grants of money and lands were made in
aid of transportation. Canals, roads, and railways were built into
new agricultural territory far faster than was healthy and normal. A
prodigal land policy put a premium upon a wastefully rapid extension
of the farming area. These things were done to favor the agricultural
states, but agricultural prices fell so greatly that our farmers for
a long period were nowhere prosperous, and great numbers of them,
both in the East and in the West, were ruined. At the same time a
high tariff on nearly everything the farmers needed to buy was the
political spoil obtained by the Eastern and Middle states. This
further depressed the condition of the farmers and forced them or
their sons into urban industries. A slower development would have
occurred without the waste of national resources in such conflicting
policies of artificial stimulation.

§ 12. #Harm of sudden tariff reductions.# It is rarely appreciated how
great is the tactical advantage which the advocates of a high tariff
enjoy in popular political discussion. They can so easily impress the
popular judgment with the evident fruits of their own policy and
with the immediate dangers of the policy of their opponents. When
a protective rate is first applied or is increased, it calls into
existence something visible and tangible, which can be measured in
terms of factories built, men employed, and products turned out. The
increased cost of these results is diffused among many consumers and
reaches them in such indirect ways and in such small increments of
price that they are quite unaware of the way they are affected.[12]

On the other hand, reduction of the tariff works in a direction the
reverse of the enactment. It may cause local crises and may even bring
on general crises. The benefits of the lower prices are diffused and
lost to view; the immediate injury is concentrated and strikingly
evident. Factories are closed, investments depreciate, laborers are
thrown out of employment. The organic nature of local industry causes
these evils to be felt by many classes. Merchants, professional men,
servants, and skilled laborers, that are tributary to the depressed
industry, suffer. The effects are transmitted to commercial and
financial centres and often credit is much shaken. Then follows a slow
and painful process of readjustment.

The low-tariff advocates in America undoubtedly have underestimated
these immediate effects. They have been too abstractly doctrinaire,
have argued too absolutely for the merits of free trade to be applied
instantly regardless of the existing distribution of investments and
of occupations. They have opposed one extreme system by another, with
no thought of the inexpediency and injustice of sweeping changes.
There is a strong feeling among business men that any tariff, be
it high or low, is better than a shifting policy. Despite the great
preponderance of domestic production over foreign trade, it is
perhaps too much to say that the tariff is unimportant in our present
conditions. It can, however, be truly said that business can adjust
itself in large measure to any settled conditions and that radical
changes, especially sudden and large reductions, are fraught with
evils. Long before a new tariff law goes into effect, even months in
advance of its passage, while it is merely in prospect, the course
of trade is abnormally affected. If the rate is likely to be raised,
large importations take place under the lower rate, and for a
considerable time after the law goes into effect imports are small,
while prices rise and domestic production gradually increases. But if
the rate is likely to fall, importations are for months meager, stocks
of goods are reduced to the lowest point, and when the lower rate
goes into effect, large importations follow to the injury of domestic
producers. In many cases a year or two of notice, time given to
enterprisers to adjust their business, would probably do away with a
large part both of the serious losses and of the lottery-like gains
that otherwise occur.

The obvious measure of precaution and of justice would be to put
any new rate into effect gradually.[13] The difficulties are of a
political nature and in the desire of the party in power to "make a
showing" at once of the results of its campaign pledges, in the one
case by starting and stimulating industries through a higher tariff
and in the other by reducing prices to consumers through a lower
tariff. Under the new permanent tariff board, constituted to suggest
tariff changes and to administer the tariff laws, it would be possible
to apply some such feature.

[Footnote 1: See above, ch. 2, secs. 12, 13.]

[Footnote 2: In European countries, on the contrary, the rates that
have been mainly effective have been those levied upon food products,
and the agricultural landholders have been the "protected interests,"
such as the England "landed aristocracy," the German agrarian
"Junkertum," and the French peasant landowners.]

[Footnote 3: See above, ch. 13, sec. 2.]

[Footnote 4: See ch. 4, sec. 6 and ch. 13, secs. 6-10.]

[Footnote 5: In ch. 13, sec. 7.]

[Footnote 6: See ch. 4, secs. 4 and 9.]

[Footnote 7: That there is a certain measure of truth in this opinion
is recognized in our discussion of the standard of deferred payments,
ch. 6, sec. 9. But the relation of a world-wide appreciation of the
standard money commodity with the burden that this change puts upon
debtors has nothing to do with the question now before us, viz.:
Does a protective tariff enable a country to keep and increase its
proportion of the world's stock of gold; and if it could, would it be
a general benefit?]

[Footnote 8: See Vol. I, especially p. 228, and chs. 34 and 36.]

[Footnote 9: See on wages in times of crises, ch. 10, secs. 6 and 7;
and on tariff changes, ch. 10, sec. 14, and ch. 15, sec. 13.]

[Footnote 10: See Vol. 1, pp. 361 and 443.]

[Footnote 11: See Vol. 1, p. 436, for average wheat prices in England,
practically in the world-market.]

[Footnote 12: See above, sec, 8. On the next paragraph, see ch. 10,
sec. 14.]

[Footnote 13: For example, the maximum alteration in any year might be
limited to 3.65 per cent of the value of the goods and in any case not
to exceed one tenth of the old duty, this change to be applied day by
day. Thus, if, on a valuation of $1000, the duty collected under the
old rate has been $400, and under the new law is to be $290.50, three
years would be required for the full change to become effective, the
reduction each day being $.10 per $1000 valuation. The administration
of such a rule would be simple, and it has been favored by men of
practical commercial experience.]

CHAPTER 15

AMERICAN TARIFF HISTORY

  § 1. Prevalence of protective tariffs. § 2. Specific and _ad valorem_
  rates. § 3. Some technical features of the tariff. § 4. The tariff,
  1789-1815. §5. The tariff, 1816-1845. §6. The tariff, 1846-1860. §7. The
  tariff, 1861-1871. § 8. The tariff, 1872-1889. § 9. The tariff,
  1890-1896. § 10. The Dingley tariff, 1897-1909. § 11. Sentiment favoring
  lower rates. § 12. The Payne-Aldrich tariff, 1909-1913. § 13. The
  Underwood tariff, 1913. § 14. Some lessons from our tariff history.
  Note on Tariff legislation and business depressions.

§ 1. #Prevalence of protective tariffs.# For a century and a half
most serious students of economics have favored a larger measure of
freedom, if not absolute freedom, in foreign trade. But the actual
practice of most nations has never been in accord with the principles
laid down by the philosophers. Great Britain alone among the larger
countries has, since 1846, steadily pursued a low tariff policy for
revenue only, and her example has been most nearly followed by Holland
and Denmark. Germany, which had always had restrictive duties, adopted
still more protective measures under Bismarck in 1879. France,
Italy, and most of the other nations of Europe have strong protective
tariffs. The United States has followed a restrictive policy since
near the beginning of the last century. The explanation of this
contradiction between precept and practice is not entirely simple.
Great interests are affected by foreign trade and certain of these
interests are able to influence opinion and to dominate legislation.
Free trade is not the most desirable thing for every one. The general
policy of free trade between nations, as advocated by most English
economists since Adam Smith, has usually been rejected by the people
and the legislators of other countries.

In its details American policy in tariff legislation under the
Constitution has been varied and vacillating. The changes have been
determined in most cases by motives of temporary partisan advantage or
by the political activity of the immediate beneficiaries rather than
by clear knowledge and consistent purpose of the electorate as a
whole. Thus its lessons for the student are largely of a negative
nature, but they well repay serious study.

§ 2. #Specific and _ad valorem_ rates.# Before entering upon the
history of the American policy let us make clear the meaning of
certain technical terms and explain certain methods which are
frequently referred to.

Rates (and duties) may be by either specific or _ad valorem. Specific
duties_ are those that are calculated and levied according to some
physical test, as so much per pound, per yard, per hundred-weight, or
per ton. _Ad valorem_ duties are those that are calculated and levied
according to the value of the goods (usually as it was at the place of
shipment) determined by an assessor, by invoice of sale, by statement
of the importer under oath, etc. The actual duty collected on any
article may result from various combinations of the two rates (as, to
take an actual example, $4.50 a pound and 25 per cent _ad valorem_
on cigars and cigarettes) or _ad valorem_ with a minimum valuation so
that on the cheaper goods the rate is specific.

Specific rates are more easily applied in administration, not offering
the temptation to undervaluation and misrepresentation that _ad
valorem_ rates do; on the other hand, specific rates do not adjust
themselves to price changes as _ad valorem_ rates do. If the prices of
goods go up the specific rate is relatively less and affords less of
"protection" to the domestic producer; whereas if prices go down (as,
in general trend, the prices of manufactured goods have done most
of the time) the specific duties are relatively greater. To take a
historical example, the specific rate of 6-1/4 cents a yard on cotton
goods in 1816 which was at first in fact only about 25 per
cent, within a few years became about 75 per cent and absolutely
prohibitive. For this reason specific rates have most often been used
in acts intended to increase the "protective" duties and often as a
device for immediately raising rates; while _ad valorem_ rates have
been more often used in acts prompted by the desire for less drastic
exclusion and for a more adequate revenue; but there is no essential
connection between the protective policy and specific rates. Indeed,
in the period from 1897 to 1909, when most prices were rising, many
of the specific rates under the Dingley Act, intended to be strongly
protective, afforded less and less "protection."[1]

§ 3. Some technical features of the tariff. All goods not subject to
duties are said to be on the _free list_. It is customary to group
articles in _schedules_, of which there are fourteen in the law of
1913, designated from A to N (for chemicals, pottery, metals, wood,
etc.), but the rates are not uniform for all the articles in each
schedule. _Drawbacks_ are a certain amount, the whole or a part, of
the duties that have been paid on imported commodities, which is
paid back by the government on the reëxportation of the goods.
_Compensatory duties_ (or compensatory rates) are those levied on
certain manufactured articles with the purpose of raising their price
as much as domestic producers' costs are raised by a tariff on their
raw materials. Examples are a duty on woolen goods to offset a duty on
wool, or a duty on shoes to offset one on hides. They may be intended
to be partial or complete or more than sufficient, and are likely in
any case to work either more or less to the advantage of the domestic
producer than was intended. It may be that the conditions of supply
are such that the home price of the raw materials is raised little
or none by the tariff while the price of the finished product is
considerably raised, or _vice versa._

§ 4. #The tariff, 1789-1815.# The main difficulty of government in
1781-1789 under the Articles of Confederation was lack of the power
to obtain revenues by taxation. The separate states alone could levy
duties, and a good many tariff restrictions on freedom of trade
among them developed in this period. The Constitution established the
principle of entire freedom of trade among the states. The first act
of Congress under the Constitution levied a tariff, primarily for
revenue purposes, but clearly having a protective purpose, in the view
of some of the representatives. However, most of the separate rates,
as well as the general average rate, were the lowest ever levied by
Congress, except that there was no free list and that 5 per cent was
imposed upon all goods not otherwise enumerated. _Ad valorem_ duties
up to a maximum of 15 per cent (that on carriages) were laid upon
certain articles of luxury, and low specific duties on a few articles
such as glass, nails, iron manufactures, hemp, and cordage.

From 1789 until 1812, thirteen tariff laws, all told, were passed. One
after another many rates were raised to get larger revenues, but some
goods were put upon the free list. The foreign trade, in both imports
and exports, grew largely and with considerable regularity, rising
then rapidly to a maximum in 1807. Then followed troublous times,
with British Orders in Council and our embargo and nonintercourse
acts until 1812, and war until 1815, trade falling off at first to
one-half, and at last (in 1814) to less than one-twelfth of the
former maximum. Just as trade was, in the war period, sinking to the
vanishing point, the tariff rates were doubled in hopes of getting
increased revenues needed for the war, but in vain.

[Illustration: FIG. 3. IMPORTS INTO THE UNITED STATES. 1821-18565

Many statistics bearing upon tariff history are graphically brought
together here. This figure should be carefully studied in connection
with the following sections. Observe how invariably in the years
following a crisis, the amounts of dutiable imports and of duties
collected have diminished, whether the tariff meantime was changed or
not.]

§ 5. #The tariff, 1816-1845.# Tho rates had been rising, manufacturers
had been making efforts to secure higher rates for protection, even
as early as 1803. Effectual exclusion of foreign goods and consequent
stimulus to the establishment of manufactures in the eastern states
resulted, in the period 1808 and 1815, from the embargoes and the war.
On the return of peace imports were resumed on a large scale and the
call for a higher tariff was loud. In the revision of 1816, rates in
a number of cases were fixed higher than those before the war. Average
rates are said to have been about 20 per cent. The rate on both cotton
and woolen goods was 25 per cent (and the minimum on cotton goods was
a specific rate of 6-1/4 cents a yard). High rates were imposed on pig
iron (50 cents a hundred), hammered bar (75 cents a hundred), and
rolled bar ($1.50 a hundred, equivalent to about 100 per cent _ad
valorem_). Rates were raised on many other articles. The average _ad
valorem_ rates collected in 1821 attained the remarkably high figures
of 36 per cent on dutiable goods, and almost 35 per cent on free and
dutiable together.

In 1824 in response to the growing sentiment in favor of the so-called
"American policy of protection," many rates were still further
increased, as those on cotton goods and woolen goods (to 33-1/3 per
cent) and some kinds of iron. Cheap wool was now taxed 15 per cent and
that valued over 10 cents a pound at 20 per cent (to be 30 per cent
after 1826). In 1828, in the "tariff of abominations" which evoked
much bitter criticism, the rates on all these goods were again raised,
those on woolen goods being in some cases 100 per cent on the value,
and those on iron being from 40 to 100 per cent on the value, and
duties were levied on molasses, hemp, and flax. The results appear
in the statistics of 1830, showing the average _ad valorem_ rates on
dutiable imports to be nearly 49 per cent, and on free and dutiable
together to be over 45 per cent. This marks a temporary high point in
tariff rates. Revenues were then becoming excessive and that year the
rates on tea and coffee and some other goods were reduced.

Violent protests, especially from the South, were made against the
protective system, and the tariff became a more important political
issue. Then in 1832 a number of changes were made, mostly downward;
the iron tariff, for example, being reduced to about the level of
1824. Average rates were thus brought down to about 33 per cent on
dutiable goods. The compromise tariff act of 1833 provided for a
process of reduction during a period terminating in 1842, the cut to
be small at first, then to be made more rapidly to bring the maximum
rate on any article down to about 20 per cent.[2] These changes, while
as yet incompleted had, in 1840, brought the average rates on dutiable
goods down to but 30 per cent and on free and dutiable together to 15
per cent. The 20 per cent rate, however, remained in effect only two
months in 1842, when it was replaced by a tariff with higher rates
distinctly protective, passed by the Whig party and which remained in
force four years.

§ 6. #The tariff, 1846-1860.# The Democratic party coming into power,
passed the Act of 1846, called the Walker tariff, after the Secretary
of the Treasury. As he was a believer in free trade, this act is often
mistakenly described as a free-trade measure. It was, in truth, far
from that. Most of the rates were indeed lower than those that had
been in force between 1816 and 1846 (with the exception of those
between 1840 and 1842), but still some of the rates were high (a few
as high as 100 per cent) and many of them were strongly protective in
nature. The fact that tea and coffee were on the free list is marked
evidence that considerations of revenue did not dominate. The rate
on cotton goods was 25 per cent and the rates on many of the most
important other protected articles (iron, woolen goods, manufactures
of iron, leather, paper, glass, and wood) were 30 per cent. The
average rates under the act for its last eight years (to 1857) were
on dutiable 26 per cent, on free and dutiable 23 per cent. The country
prospered for eleven years under this tariff. In 1857, rates were
again reduced, the more important protective rates from 30 per cent
to a level of 24 per cent. This time partizan considerations played
no part in the discussion. The revenues of the government had been
excessive and the need of a reduction was admitted by nearly every
one. The average _ad valorem_ rates under the nearly four years of the
act of 1857 were about 20 per cent on dutiable and 16 per cent on free
and dutiable (the lowest in the century between 1812 and 1913).

§ 7. #The tariff, 1861-1871.# The reduction of rates in 1857 was
made just at the time when the country was at the height of a wave of
prosperity and of speculation which culminated in the financial crisis
of that year.[3] As always at such times, the government's revenues
fell greatly. The first purpose in the revision of the tariff in 1861
was simply to restore the rates in the act of 1846. But the Morrill
act which became a law just before Fort Sumter was fired upon,
contained many higher rates and its purpose was avowedly protective.
This necessarily involved a sacrifice of possible revenues for the
government.[4] Then from the beginning of the Civil War till its close
some rates were raised almost every month with little scrutiny or
debate. The average _ad valorem_ rate jumped from 19 per cent on
dutiable in 1861 (under the law of 1857) to an average of 35 per cent
in the three years, 1862-1865.

The most important tariff acts of the war were those of 1862 and 1864
by which large increases were made on many articles. These tariff
acts were passed in connection with far-reaching and burdensome
applications of internal revenue taxes on many kinds of manufactures.
The tariff rates were primarily intended to offset these taxes, "to
impose an additional duty on imports equal to the tax which had been
put on the domestic articles," as was said by the sponsors of the
bill. These rates were similar in purpose to compensatory rates, and
in many cases they were more than sufficient to offset the internal
taxes. Under the last of these acts the duties collected in the six
years from 1865 to 1870 averaged nearly 48 per cent on dutiable and
nearly 44 per cent on free and dutiable.

The remarkable fact was that soon after the war the internal revenue
taxes began to be repealed one after another, and by 1872 nearly
all those bearing upon general manufactures (apart from cigars and
alcoholic beverages) were gone. The tariff, however, remained almost
unaltered. This repeal of internal revenue taxation had the same
"protective" effect as raising the tariff rates by so much. As if
this were not enough for the protected interests, in 1867 the duty on
woolens was further raised and in 1870 numerous other increases were
made in the duties having a protective character. Some reductions were
made, but these were almost all on articles of a distinctly "revenue"
character such as tea, coffee, sugar, molasses, spices, wines.
Revenues were superabundant for current expenses of government, and
altho there was a large national debt, hardly any of it was redeemable
at the time. There was therefore need to reduce taxation, but the
attention of the consuming and tax-paying public was distracted by the
somewhat passionate political issues of the day. Besides, the public
had not the technical knowledge or the unified opinion on this subject
to protect itself against the greedy lobby in this process of tax
revision. And so, selfish commercial interests could get nearly what
they asked for in Congress, and the politicians at Washington, who had
come to have a well-nigh superstitious faith in the efficacy of very
high protective duties, could quietly use the opportunity to raise the
people's taxes for the people's good.

These virtual increases in the protective power of the rates in force
are not evident in the statistics of average _ad valorem_ rates,
because the higher rates in many cases were sufficient to exclude
relatively more of the foreign products to which they applied.[5] The
imports came, by a process of selection, to consist more largely of
goods subject to lower rates. So the year 1868 showed the highest
average rate on dutiable goods (48.6 per cent) of any year after the
act of 1828 until that of 1890, and the rate fell somewhat each year
until in the fiscal year 1872 it was 41.3 per cent.

§ 8. #The tariff, 1872-1889#. In 1872 the country was again, as in
1857, nearing the crest of a wave of prosperity and of speculation.
Imports and customs receipts attained new high points in our history,
and, despite the enormous reductions of internal revenue taxation,
the government's receipts continued to be excessive.[6] The important
revenue articles, tea and coffee, were then transferred to the free
list, as were also raw hides and paper stock and some other articles;
the rate on salt was reduced one-half and that on coal almost as much.
Many other specific rates were reduced and the _ad valorem_ rates on a
long list of articles were cut to "90 per cent of existing rates."
The effects of these reductions were mingled with those of the severe
financial panic occurring in 1873 and of the depression following,
which reduced especially the importation of luxuries bearing the
higher rates. The average rate of the three (fiscal) years 1873 to
1875 was 39 per cent on dutiable (a fall of 9) and 28 on free and
dutiable (a fall of 16). The ratio of imports entering free, which in
1872 was still only about 1 in 14, became the next year 1 in 4. But
government revenues falling short in 1874, advantage was soon taken
of the circumstance to repeal in 1875 with little discussion the
horizontal cut of tariff rates made in 1872. The specific rates that
had been reduced in 1872 were little changed, however. From 1876 to
1883 (8 fiscal years) nearly a third of the imports consisted of goods
on the free list. The average rate on dutiable was over 43 per cent,
and on free and dutiable was 30 per cent.

The tariff was a leading issue in the campaigns of 1876 and 1880. In
1876, the Democratic party's platform contained a plank for "a tariff
for revenue only." It was a time of great industrial depression, and
as is usual in such cases a large number of the electors held the
party in power responsible for business adversity (as in turn they
credit it with any more or less fortuitous prosperity). The Republican
candidate Hayes, after a long contest in Congress, was declared
elected by a margin of one electoral vote. His opponent, Tilden had
received a quarter of a million more votes in the country as a whole.
In 1880, when business prosperity was rapidly returning, the party
in power was successful by a goodly margin of votes in the electoral
college, tho having a bare plurality of the popular vote. Garfield,
the Republican candidate, was known as one of the more moderate
protectionists and his opponent, General Hancock, who was without any
political record, declared the tariff to be a "local issue," to be
determined in the Congressional districts. The tariff issue was thus
not very sharply drawn. The tragic death of President Garfield left
no clear leadership. The tariff question from 1876 to 1884 was
politically in the doldrums.

Yet there was undoubtedly a somewhat growing popular demand for some
moderation of the very high duties. To this demand the friends of
protection who were in power felt compelled to concede something--or
to appear to do so. Congress appointed a Tariff Commission of which
the Chairman was secretary of the wool manufacturers' association, and
after a report the tariff act of 1883 was passed. The net results were
almost nil. Some rates were lowered, while others were raised with a
definite protectionist purpose. The average rates for the next seven
years, 1884-1890, were 45 on dutiable (an increase of nearly 2 per
cent) and 30 on free and dutiable (unchanged as compared with the
period ending 1883). In 1884, the Democratic party elected its
presidential candidate (Cleveland) and a majority of the House, but
as it did not control the Senate it could not pass any of the various
proposed measures for a "reform" of the tariff. In 1888 the protective
principle was a leading issue in the campaign. Altho Cleveland
received a few ten thousands larger popular plurality than he had
obtained four years before, and held the electoral votes of 18 of the
states, he lost New York and Indiana by very narrow margins, a result
in which other issues played a large part. Harrison was elected and
the party favoring a high protective tariff came into power.

§ 9. #The tariff, 1890-1896#. The tariff act (known as the McKinley
act) of October, 1890, followed. This was a general extension of the
principle of protection. The rates on woolen goods were on the whole
increased and made in more cases prohibitive. The rates on wool were
increased. The rates on iron, which was already highly protected, were
little changed except by the increase of the duty on tin-plates. The
duty on sugar (in the main a revenue duty, yielding $55,000,000
a year) was removed and a bounty was granted to domestic sugar
producers. In the next three (fiscal) years, 1892-1894, the average
rate proved to be over 49 per cent on dutiable (4 per cent increase)
and 22 per cent on free and dutiable (the remission of sugar duties
accounting for the most of this fall of 8 per cent from the average
under the preceding law--4 per cent fall from the last year of its
operation). Particularly noticeable, however, was the increase in the
proportion of goods entering free, which was nearly 55 per cent of
all merchandise as contrasted with about 33 per cent between 1884 and
1890.

Again the political weather vane shifted. The month after the McKinley
bill became law, the Congressional elections (November, 1890) returned
an overwhelming Democratic majority in the House, altho this was a
period of business prosperity, a fact usually favoring the party in
power. In 1892, Cleveland, being again a candidate, was successful
over Harrison by a largely increased plurality of the popular vote,
and received almost double the electoral vote of his opponent.
The House was Democratic, and the Senate soon became so. Business
prosperity was rising again to a high level, but there were many
features of financial and speculative weakness in the situation,
intensified by growing fear of a cheap money (silver dollar) inflation
under the act of 1878 providing for the annual purchase of silver.
A financial panic occurred in September, 1893, six months after
Cleveland's inauguration.

Nevertheless Congress enacted the next year, Aug. 28, 1894, the Wilson
tariff act. The changes made by this legislation were not on the whole
very great, but were nearly all in the direction of the lowering of
the tariff. Most notable was the putting of raw wool upon the free
list. Some rates on woolen goods were reduced, but hardly more than
enough to offset the effects, upon manufacturers' costs, of the
reduction of the tariff on raw wool. Likewise small reductions were
made on cotton and silk goods, on pig iron, steel and tin plate
and many other articles; and larger reductions on coal, iron ore,
chinaware, and glassware. To make up for the expected reduction of
receipts from other sources, a duty was laid again upon raw sugar,
and an income tax law was passed (this soon, however, to be declared
unconstitutional).

Under this law, for three fiscal years (1894-1897) the average
rates were 41 per cent on dutiable and 21 per cent on free and
dutiable,--pretty high rates. The proportion entering free under this
act was actually less than under the McKinley act, partly because
of the sugar item, and partly, probably, because of general business
conditions.

§ 10. #The Dingley tariff, 1897-1909.# The campaign of 1896 was waged
almost solely on the issue of free silver. Undoubtedly great numbers
of voters supported William McKinley rather despite of, than because
of, his high protectionist beliefs. But his inauguration was promptly
followed by the passage of the Dingley act of July 24, 1897, which
embodied a marked increase of protective rates. A duty was again
levied on wool, and also on hides which had been untaxed since 1872.
High rates were made for woolens, linens, silks, chinaware, and the
rate on sugar was doubled. Provision was made for some reduction of
rates by reciprocity agreements, but the conditions were so complex
that the effect could not be great. This high protective tariff, thus
enacted without popular discussion, remained almost unchanged for
twelve years, the longest life, by one year, of any tariff act in our
history,[7] The rate under the first full fiscal year of the law's
operation, 1899, was the highest on dutiable in our history, 52 per
cent, and was nearly 30 per cent on free and dutiable. In practical
operation, however, the average rate steadily became more moderate
because of the rapid rise of the general price level that was in
progress throughout this period, amounting to 35 per cent from 1898
to 1909.[8] The average rate of duties collected for the period of
12 years was 47 per cent on dutiable and 26 per cent on free and
dutiable. It was steadily falling and the last year, 1909, was 43 per
cent on dutiable and 23 per cent on free and dutiable.

§ 11. #Sentiment favoring lower rates.# While the Dingley act was thus
in operation showing declining average rates, sentiment was developing
in every part of the country in favor of a further moderation of the
tariff. This was due partly to the discontent resulting from steadily
rising general prices, in which change the rise in the prices of food
and of many other necessities was not fully compensated by the rise
of the wages and incomes of the masses. Partly the growth of this
sentiment accompanied the agitation against trusts and the belief
that protective duties in some cases were an aid to the formation of
domestic monopolies. But more fundamentally, this changing sentiment
was the result of the changing industrial conditions in America. The
character of our foreign trade had altered greatly since the early
nineties. We were importing relatively less and less of manufactured
and finished products, and more of raw materials; and we were
exporting less and less of raw materials and more of finished
products. A growing number of manufacturers were feeling the need of
cheaper raw materials and were looking hopefully toward an enlargement
of their foreign trade.

The Republican platform in 1908, in view of the changing public
sentiment, formulated a new rule for maintaining "the true principle
of protection," namely, that it "is best maintained by the imposition
of such duties as will equal the difference between the cost of
production at home and abroad, together with a reasonable profit to
American industries." This rule is very attractive in its suggestion
at the same time of the idea of a moderation of the tariff and of an
exact practical (not to say scientific) standard for the determination
of the proper rate in every case.

The rule is, however, fallacious. "Costs of production" mean here
the monetary costs of the enterpriser. Now a first difficulty is that
costs are not uniform for all establishments in any one industry, and
a tariff high enough to protect some is entirely too low to protect
others. As long as a tariff rate is too low to exclude every unit of
the foreign product its importation is conclusive proof that for some
home producers the tariff rates fall short of the "true principle"
(better proof, indeed, than the most elaborate investigation by any
tariff board could be). The indubitable truth is that no trade ever
can take place (in a monetary régime) unless the monetary price is
lower in the exporting than it is in the importing country. This
virtually means that the product cannot be profitably exported unless
the monetary costs of production ("together with a fair profit") of
the article exported are for each party less than those of the other
party in the other country.[9] The so-called "true principle" would
lead thus to absolute prohibition of every article to which it was
applied.

§ 12. #The Payne-Aldrich tariff, 1909-1913#. In the campaign of 1908
the Republicans admitted that the protective tariff needed to be
revised, but they declared that it should be revised by its friends.
It was doubtless the general understanding that "revision" in this
promise meant revision downward, tho this was left somewhat unclear in
a campaign wherein the tariff played a somewhat minor part. The tariff
act of 1909 (the Payne-Aldrich act) was the attempt of the successful
party to redeem its promise in this regard. Many changes of rates were
made, both downwards and upwards. It was estimated that rates were
reduced in 584 instances, affecting 20 per cent of imports. These
changes included placing hides upon the free list (before taxed 15 per
cent), and cutting down the rate on leather, shoes, coal, lumber,
iron ore, pig iron, and steel-rails. But on the other hand rates
were increased in 300 instances (including many items in the cotton
schedule). The general belief that little reduction was effected, on
the whole, was confirmed by the experience under the act. As compared
with the last two years (1908-1909) of the Dingley tariff the first
two years of the Payne-Aldrich tariff showed a decline of 1.5 per
cent, and on free and dutiable a decline of less than 3 per cent.
These reductions in the statistical results are no greater than
occurred within like periods while the Dingley act continued in
operation without change.[10]

No other tariff since "the act of abominations" in 1828 has called
forth such widespread criticism as this one, and the tariff became
a leading issue in the campaign of 1912. After 1910, the House being
Democratic, many bills to reduce duties were presented, and some were
passed by both houses, but all were vetoed by President Taft mainly
on the ground that it would be best to await the report of the tariff
board which had been authorized and appointed for the purpose of
ascertaining the cost of production referred to in the "true principle
of protection."

§ 13. #The Underwood tariff, 1913#. After President Wilson was
inaugurated, March 4, 1913, the tariff was at once taken up by
Congress. The general features of the act that was passed were as
follows:

(a) Considerable additions to the free list of raw materials.

(b) Abolition of compensatory duties corresponding with the old rates
on raw materials.

(c) Replacement of specific by _ad valorem_ rates in many cases.

(d) Taxation of plain kinds of goods less than fancy kinds--luxuries
higher than necessities.

(e) Reduction of rates generally (most of the few increases being to
correct some evident error in the old law).

(f) Application of the so-called competitive principle to rates
intended to be protective, viz., to leave the rate just barely high
enough to keep out foreign products.[11]

Articles placed on the free list were raw wool (which had borne a rate
equivalent to about 44 per cent), metals, agricultural implements, raw
sugar (the lower rate to go into effect gradually), coal, lumber, many
agricultural products including live cattle, meats, wheat, corn,
flax, tea, and hemp, and numerous manufactures including boots, shoes,
gunpowder, wood pulp, and print paper.

Moderate reductions were made in the schedules for chemicals, earths,
cotton goods, and sundries, while rates on various luxuries were
either unchanged or raised. Left almost unchanged were the schedules
for tobacco, for spirits and wines, and for silks (already very high).

This act was signed October 3, 1913, and had been in operation about
nine months when the great war broke out in August, 1914. What its
effects would have been under normal conditions we can judge little
from the actual experience. The first eight months that the act was in
operation, the _ad valorem_ rate on dutiable goods proved to be 36 per
cent (about 4 per cent less than in the preceding year) and the rate
on free and dutiable together about 14 per cent (over 3 per cent less
than the preceding year). The first complete fiscal year (that of
1915) under the act, the average rate on dutiable goods was 33.5 per
cent and that on all imports was 12.5 per cent. Evidently this is far
from a "free trade tariff." The reduction in the average _ad valorem_
rate is less than was expected. Many of the reductions had little
effect, the former rate having been much higher than was needed to
exclude the goods. In other cases the old rates were but nominal
and inoperative because they were upon goods regularly exported,
not imported (e.g., farm products, cotton goods, and some other
manufactures). But some of the reductions doubtless will force the
less efficient plants in some industries touched to increase their
efficiency or go out of business. Time, in any normal period, is
needed for adjustment, but an adjustment of a most abnormal kind is
in progress during the war. Imports from Europe have fallen greatly,
while exports are enormously increased. Old industrial establishments
have been converted to different and temporary uses. The conclusion of
the war must bring a new readjustment that must cause a severe shock
to some enterprises--and this must have been so under any possible
variety of tariff.[12]

§ 14. #Some lessons from our tariff history.# Can we draw from the
checkered course of tariff history in America clear lessons of wisdom
for the future? At least certain negative conclusions may be safely
drawn. It is a history of a vacillating public opinion toward the
policy of protective duties. Always the policy has kept some hold
on public sentiment, but it has varied in strength, now waxing, now
waning. The time of revisions has been determined nearly always by
varying needs of revenue. When more income has had to be raised, this
has nearly always been made the occasion and pretext for increasing
the degree of protection for many industries. This is not at all a
necessary connection, for it would be possible to couple internal
revenue taxes and customs duties in such a way that the rates would go
up and down together and give the varying amounts of revenue
required for the government without appreciably altering the relative
profitableness of various private enterprises.

Our tariff history is too largely a record of special favors granted
to classes of citizens, to the citizens of certain localities, and to
particular enterprises. This is apparent even in a general survey, but
almost every more detailed examination of particular protective rates
reveals evidence of suspicious and sometimes scandalous personal
influences at work. The protective policy has always professedly
been advocated for the general welfare to raise wages or to make the
country prosperous, but the initiative has always been taken, and
the valiant work in contributing funds for campaign purposes and
in lobbying bills through Congress has been done, by the interested
manufacturers. Even if it were beyond question sound in principle to
exclude goods that can be bought more cheaply by trade, it is very
doubtful whether any net good could have resulted from this policy
as it has been in fact applied and followed. The frequent and
unpredictable changes have been a great evil, and have again and again
brought unmerited losses to the many in business and still greater
and unearned gains to a favored few. It is incredible that such a
hit-or-miss, in large part selfishly determined, policy could have
been an important cause of our national prosperity. The fundamental
causes of the general high wages and popular welfare that we have
enjoyed is to be found rather in our rich natural resources,
our capacity for self-government with free institutions, and the
industrial energies of our people.[13]

The revision of the tariff of 1913, viewed with non-partizan eyes,
appears to have been carried out, to say the least, as consistently
with regard to its professed doctrine, and as little influenced by the
malevolent arts of the old-time Congressional lobby, as any debated
tariff act in our history. It still contains on the whole a large
measure of protection. Under various pretexts such as the danger of a
flood of cheap goods after the close of the great war, attempts will
be made to make it still more prohibitive. But one lesson of our
tariff history is that such an act should be given a period of fair
trial before extensive changes are made in it. Even further reductions
should be cautiously undertaken and put into effect gradually. If the
attempt is made through temporary rates to reduce the shock of the
trade adjustments, of the "dumping" after the war, then the devising
and administration of such measures should be delegated to an
expert, disinterested, permanent tariff board. The task is to prevent
temporary "unfair competition" and sudden changes, rather than to
raise permanent barriers to fair trade.[14]

[Footnote 1: It is evident that it is only through _ad valorem_ rates
that it is possible to compare the average rate of duty for one tariff
act, with that for another. As, however, every tariff act is made up
of both specific and _ad valorem_ duties, it is only at the end of the
year that an average _ad valorem_ rate can be estimated by comparing
the total of duties collected with the total estimated value of the
goods imported. Average _ad valorem_ rates are estimated in this way
both on the dutiable goods alone, and on all goods, free and dutiable
combined. There may be an element of error, even of misrepresentation,
in such estimates. They do not give the simple test of the relative
height of duties, or of the degree of "protection" that we might at
first suppose. Just to the extent that a new and higher rate really
operates to exclude imports (and thus is protective in its effect) the
goods subject to that rate cease to form part of the total imports.
For example, if the average rate of duty were 25 per cent, and a
50 per cent rate on an article were increased to 75 per cent, it is
possible that this rate would prove to be absolutely prohibitive.
This raise of rate, therefore, would tend to reduce the average rates
collected on all dutiable articles. Changes in general conditions
of industry from causes quite apart from the tariff may result in
shifting the proportions of imports that are dutiable so that the
average rates go either up or down while the tariff law has remained
unchanged on the statute book. A failure to consider these and related
facts leads to much confusion in popular and political discussion of
the tariff.]

[Footnote 2: Usually given as 20 per cent. However a good many rates
under the full operation of the act worked out as 21-1/2 or 23 per
cent, and a few at 26 and at 29 per cent. Besides there were
numerous specific rates, the _ad valorem_ force of which cannot be
determined.]

[Footnote 3: The political argument that the small tariff reduction of
1857 caused the crisis of 1857 will not bear serious examination. See
below, sec. 13.]

[Footnote 4: See ch. 14, sec. 2.]

[Footnote 5: See above, sec. 2, note 1.]

[Footnote 6: Internal revenue receipts in 1866 had been $309,000,000;
in 1872 they had fallen to $131,000,000, yet the government's surplus
for the three years 1870-1872 was little less than $100,000,000 a
year. This was almost half of the total receipts from customs, which
were $216,000,000.]

[Footnote 7: Other issues absorbed public attention in this
period--the Spanish war, colonial policy, "imperialism," railway rate
regulation, corporation control, etc.]

[Footnote 8: See above, sec. 2.]

[Footnote 9: Compare with ch. 13, sec. 5.]

[Footnote 10: Probably resulting from the rising prices, as explained
above, sec. 2. For example, in one year, from 1899 to 1900, the
average _ad valorem_ rate collected on dutiable goods fell 3 per cent,
and that on all goods fell 2 per cent; in the two years from 1904 to
1906 the average rates on dutiable fell 4 per cent, and on all goods
fell 2 per cent.]

[Footnote 11: This "competitive principle" is essentially the same as
the so-called "true principle" of equalizing the cost of production
(see above, sec. 11). It is essentially a prohibitive, not a free
trade, principle. Strictly applied it would cause complete exclusion
of imports. But as applied to selected articles which it is desired
to exclude in order to "protect" the domestic producer, this principle
would simply prevent the rate being placed appreciably higher than
was needed to exclude them. Anything beyond that point but offers
temptation and opportunity for the formation of a monopoly by domestic
producers. Then, too, the rate may intentionally be fixed so as to
make just possible the survival of the most favorably located or most
efficiently operated establishments, while compelling the abandonment
of other establishments. See ch. 14, sec. 3.]

[Footnote 12: Such changes are logically related to the subject of
financial crises rather than to that of the tariff. See note at end of
the next section.]

[Footnote 13: See Vol. I, e.g., pp. 228, 431, 445ff, 466, 490, 506ff.]

[Footnote 14: #Tariff legislation and business depressions.# The
relation between new tariff legislation and the business conditions
following it has been the subject of much debate in political
campaigns. In the few cases where a relationship has been most often
asserted to exist, it is more probable that the tariff change was the
_result_ of business conditions preceding it, than that it was the
cause of the conditions following it. For usually a tariff has been
revised downward because a few years of prosperity with large imports
had so increased customs duties that the government has had surplus
revenues. Just when the tariff was reduced, the conditions were ripe
for a crisis. This happened in 1857 (already in 1856 there had been a
preliminary halt of business), again in 1872, and on a small scale in
1883. But the main reduction resulting from the compromise act of 1833
did not occur until after the crisis of 1837-39; the Walker act of
1846 was passed just as business was starting upward on a long wave
of prosperity; and the act of 1894 was passed a full year after the
severe crisis of 1893, when business had already entered upon a period
of depression. In none of these cases does it seem reasonable to
attribute business depression to the reduction of the tariff, as
is commonly done in protectionist arguments even to the point of
attributing the panic of 1893 to the reduction of the tariff a year
later!

At several times the tariff has been raised soon after a crisis when a
good occasion was presented by the need of larger revenues as in 1842,
1860, 1875, and 1897. Business at such times is just at the point
of the cycle when prosperity is due. The higher tariff of 1842 was
succeeded by the low tariff of 1846 without any check to business. The
war obscured the ordinary industrial effects of the tariff acts of the
sixties. The increase in the year 1875 was followed by four years
of hard times and slow recovery. The increase of the tariff in 1890
occurred as business was nearing the top of the cycle and was followed
by two years of prosperity culminating in the very severe crisis of
1893. The authors of the tariff of 1897 were peculiarly fortunate in
the time of their action, for the country was just fairly recovering
from the very severe crisis of 1893 and prosperity was to continue
(with brief hesitation in 1900 and 1903) until the severe crisis and
panic of 1907.

The advocates of higher rates are, of course, correct in declaring
that the great business prosperity of the years 1915 and 1916 resulted
from the unexpected demands in foreign trade growing out of the war,
and is not to be credited in large measure to the act of 1913. But
reason requires that the same restraint be exercised in crediting
to higher protective acts the prosperity which has in some--not
all--cases, followed their enactment; and requires further that the
present act be not held accountable for the next reaction in trade,
whenever it may occur, inasmuch as a reaction would be sure to occur
no matter what kind of tariff act we might chance to have at the
time.]

CHAPTER 16

OBJECTS AND PRINCIPLES OF TAXATION

  § 1. Public finance as a division of economics. § 2. The police function.
  § 3. Social and industrial functions. § 4. The enlarging sphere
  of the state. § 5. Industrial revenues of governments. § 6. Governmental
  receipts from loans. § 7. Nonrevenue character of receipts from
  loans. § 8. Revenues from taxation. § 9. Forms of taxation. §10.
  Defective tax "systems." §11. Various standards of justice suggested.
  § 12. Social welfare as the aim. § 13. Principles of administration.
  § 14. Shifting and incidence. § 15. Taxes as costs.

§ 1. #Public finance as a division of economics.# Men live together
in politically organized societies which employ public officials as
agents to carry on the functions of government. Every governmental
unit, large or small, may be viewed not only as a political body,
but as an economic enterprise. Each has its economic aspects, such
as receipts and expenditures, employer and employee, borrowing and
lending, etc. Each political unit is in this sense "an economy." The
study of the public economy, of the economic aspects of government as
distinguished from its political aspects, constitutes the science of
public finance, an important division, tho not the whole, of political
economy.

The primary fact determining the public finances is the extent of the
sphere of "the state," meaning by the state the totality of political
powers and functions in a community. There are two typical ideals of
a state, each with corresponding functions: the ideal of the police
state, and that of the social-industrial state. In fact every system
of government provides for the exercise of both functions in some
measure. The police function is primary. All governments alike
exercise it, but they differ most in respect to the degree in which
they exercise the social-industrial functions.

§ 2. #The police function.# The police function is that of public
defense and the maintenance of domestic order. In family or
patriarchal communities all share a common income and combine in the
common defense, but self-preservation often has compelled such small
communities to form a larger, stronger state for the common defense.
Public defense requires sacrifice of some independence on the part of
the family and of the individual. Personal service in the field gives
place later in some measure to the payment of taxes, so that a regular
income may permit the government to attain a more regular, continuing,
and perfect organization of military forces.

As political unity and power grow, the citizens need less often
protection against foreign foes, and they need more often, relatively,
defense against the aggressions of some of their own countrymen. The
preservation of domestic order requires police, courts of justice, and
other agencies. The ideal of the anarchist to do without government
is nowhere realized. Everywhere there must be government to preserve
peace and to protect property. Unfortunately, this need grows with the
growing density of population. Crime increases when men swarm in
great cities. The courts which settle disputes between men, and which
interpret their contracts, are agencies of peace, displacing physical
contests. To maintain and operate the various parts of the social
machinery requires ever increasing governmental revenues. From many
causes government has, in modern times, grown increasingly costly.

§ 3. #Social and industrial functions.# The social and industrial
functions of government seem naturally to grow out of the primary
ones just mentioned. In a democratic society, popular education is
a necessity, as it appears that domestic order is not possible in a
democratic state without intelligent citizens. The system of public
education has, in many states, expanded to include a publicly
supported university as the dominant educational and scientific organ
of the community. Some industrial functions are performed by the
government in connection with the primary needs. Lighthouses are
necessary to guide the navy, but they also serve to guide the merchant
marine and to aid industry. The post was established as an agent
of political and military government to connect the ruler with the
outposts (a fact the name post indicates), but the postal service has
grown in every country to be a great industrial and social agency.
The consular service, originating in the political need of keeping
official representatives in foreign lands, has become a valuable
economic agency; consuls are commercial agents, advancing the business
interests of their countries in all quarters of the globe.

§ 4. #The enlarging sphere of the state.# A mere police state would
leave to private initiative the provision of every kind of economic
agencies not needed for political government. The state might, for
example, even leave the provision of roads and bridges to private
individuals or to companies, permitting them to charge tolls to obtain
a return on their investment. Whenever a toll-road is made public and
a toll-bridge becomes free, and the state maintains the roads, it is
becoming less strictly a mere police state. Reacting from the ideal
of the police state which was most highly praised in the first half
of the nineteenth century, the functions of government have been
extending in many directions in the last half century. More and more
economic functions are performed through the agency of government. If
we think of an act as done by the government _for_ private citizens,
we call it paternalism; but if we think of an act as done _by_
citizens collectively _for_ themselves as the best way to get these
things done, we may call it, in a broad sense, socialism.[1]

Government is in one aspect a direct good to its citizens. In return
for its collective cost men collectively get the enjoyment of social
organization, markedly in contrast with the uncertain ties and hazards
of primitive communities. But government becomes also a mode of social
investment, an indirect agent, a productive enterprise. Wealth applied
through it secures in some cases a greater product than is possible by
individual action.

But when the government undertakes these various tasks the expense
falls unequally on individuals and affects differently their incomes.
When free schools take the place of private schools, the law compels
every one to contribute to education. To many individuals it is a
matter of indifference whether they pay tuition or taxes, but the
wealthy bachelor sometimes grumbles when forced to help in educating
the day-laborer's family. The average result of a certain social
policy may be right, but individuals diverge from the average and
thus have constantly a motive to attempt to change the limits of
governmental action. Happily the subject is not always viewed with
selfish eyes. The ethical and patriotic thought is not, "How will this
affect my interests?" but. "How will it affect the general interests?"
But as the question of value is always involved men are usually found
favoring or opposing the industrial and social activity of the state
according as it affects their own incomes. Thus the determination of
the sphere of the state is in large part an economic question.

§ 5. #Industrial revenues of governments#. The costs of government at
any stage are met in varying degrees in one of three ways: (1) from
industrial sources, (2) by borrowing and thus creating a public debt,
(3) from taxation.

(1) Receipts from industrial sources in the broad sense include all
rents from wealth owned, interest on loans made, and proceeds of sales
from enterprises conducted, by the government. In feudal times, these
were mostly obtained in the form of rents from the private domains of
kings and nobles. In many early and medieval states these sources of
receipts were adequate to the need of government; then they decreased
in many countries, both relatively and absolutely, because of the
sale of publicly owned wealth (lands and mines) and with the recent
extension of the functions of government have again increased very
rapidly. Now industrial revenues come not only from the rents of
forests, mines, docks, lands, and buildings, but from profits in the
operation of industrial enterprises such as waterworks, railways,
mines, and factories, and from interest on funds deposited in banks
or otherwise invested. At present the industrial revenues of the
aggregate governments of the United States (national, state, and
municipal) amount to about a fifth of all revenue receipts. Since
the middle of the nineteenth century the number and variety of the
industrial enterprises undertaken by governments has been steadily
increasing, and this increase has been most marked in the cities. The
change in this respect in the United States, great as it has been, has
been proceeding more slowly than in the European countries.

In 1913 the receipts of this nature (earnings of departments and of
public service enterprises) were nearly $500,000,000. The larger part
of this sum comes to the national government ($288,000,000), mostly
from the post-office department. Most of the remainder comes to the
minor divisions ($176,000,000), and but little to the states. The
total "earnings" (this means here receipts, not profits) of public
service enterprises in incorporated places were $120,000,000.

§ 6. #Governmental receipts from loans.# The funds to invest in these
commercial undertakings are originally obtained in nearly all cases
from public loans. Almost every unit or division of government may
become a borrower to provide for its citizens at once certain needed
advantages and improvements when the funds are not at hand and
immediate taxation is deemed too heavy a burden.[2]

The indebtedness (less funds available for payment of debt) of the
aggregate governments of the United States in 1913 was:

  Nation  .................................  $1,028,000,000
  States  .................................     346,000,000
  Minor divisions .........................   3,476,000,000
                                              -------------
  Total   .................................. $4,850,000,000

The larger part of nearly every national debt has been incurred for
purposes of war and preparation for war, while nearly all public
debt other than national has been created for the purpose of peaceful
social and industrial development. The debts of the American states
have partly been made necessary to meet deficits in current expenses,
but largely of late to erect public buildings, purchase forest lands,
improve roads, and construct canals. The minor divisions are counties,
cities, villages, boroughs, towns, townships, school districts,
drainage, irrigation, and levee districts, fire districts, poor-relief
districts, road districts, and various other subdivisions of states
and of counties. Every one of them has more or less legal power to
incur debts and to levy taxes for the purpose of paying the interest
and of repaying the principal. The purposes for which the debts are
incurred by specially organized districts are sometimes indicated in
the names (e.g., drainage, irrigation), while the regular political
divisions of counties, cities, villages, towns, townships, incur debts
for a large variety of objects, such as streets, sewage disposal,
water supply, electric light or gas plants, school houses, libraries,
and other public buildings. Large expenditures for these purposes are
necessary because the local governments are undertaking new functions,
and either existing equipment (such as waterworks systems, and street
railways) must be bought from private companies or new ones must
be built. They are necessary further because the rapid growth of
population calls for an immediate "capital investment," the payment of
which may be, through borrowing, more easily spread over a series
of years (e.g., in the extension of streets and paving, and in the
provision of school houses for the children).

§ 7. #Nonrevenue character of receipts from loans.# The proceeds
from loans (and certain other items of sales) are called nonrevenue
receipts, because they are but in anticipation of receipts from other
sources. The economic theory of such loans is essentially the same as
that of private loans, but it is the people of the political district
collectively that are the borrowers. To get the present uses of goods
they sell their promise to make future payments totaling a larger
amount. The loan is the present worth of those promises. In the case
of loans made for local purposes, provision is now usually made for
their complete repayment within a definite number of years,
usually 10, or 20, or 30. Meantime interest is payable annually or
semi-annually, and from some source an additional sum is collected
to repay a part of the loan, sometimes by redeeming a certain part
annually, sometimes by accumulating a sinking fund until that amounts
to the whole debt.

The minor divisions in the United States are thus constantly creating
debts at the rate of about $2,000,000,000 each year and at the same
time paying former debts in instalments, in a total amount somewhat
less than this. In the case of some municipal investments which are
commercial enterprises (such as those supplying gas, electricity, and
water), these annual payments can be made out of the profits; in the
case of others, the payments come from special assessments upon
the owners; and in most other cases they are collected by the usual
methods of taxation. In America, a large part of these costs are, by
the law of special assessments, placed upon the owners of adjacent
lands, whose outlays are usually more than offset by the increased
value of their lands as a result of the improvements. In this case
also, the present investment is in anticipation of the future incomes
which the owners of the improved lands will get.[3]

§ 8. #Revenues from taxation.# Much the largest part of the receipts
of most governments, apart from loans, and in many cases nearly all
such revenue receipts, come from taxation. Tax (as a verb) meant
originally to touch or handle, then to estimate or appraise, and then
to charge a burden upon some one, especially to impose a payment of
services, goods, or money upon persons or property for the support
of government.[4] _Taxation_ is the legal process of taking income,
services, or wealth from private persons for public uses.

Taxes are of various kinds, but they always are incomes, or wealth
representing future incomes, transferred from private ownership of the
taxpayers to the government. In rare cases, more than the net current
income of a certain kind may be taken for public uses. As economic
income has many sources, it may be intercepted at many different
points, and taxation may take various forms. The differences are
so manifold that it is difficult to classify particular taxes
satisfactorily.

§ 9. #Forms of taxation.# The following are the forms of taxation most
frequently referred to.

(a) The simplest form of tax is a _poll tax_, a uniform amount payable
by every person of the taxable class. This form of tax is being
less and less used in America and now amounts to little more than
$17,000,000,[5] this being only .6 of 1 per cent of the aggregate
taxes in the United States. The national government gets about
one-fourth of this amount from a tax on immigrants and the rest is
collected by (some of) the states, counties, and minor divisions.
Usually, if not always, the poll tax is imposed only upon voters, as a
condition to the right to vote.

(b) Taxes may be laid upon _incomes_, as they come into the possession
of the owner. Usually, only monetary incomes that arise in commercial
transactions are taxable, and no attempt is made to estimate the value
of psychic incomes. Commercial incomes are more easily measured, but
the omission of the other elements must cause many inequalities in the
burden of the tax as between two individuals controlling equal incomes
of real things.

(c) Taxes may be on _property_, either general upon all property in
the taxing district, or special, upon certain forms of property. A
property tax may be specific or _ad valorem_, in proportion to value,
as to the method of its determination. Since the value of material
wealth is the capitalization of the rentals at the prevailing rate of
interest, a general, _ad valorem_, property tax, so far as it applies
to material wealth, and if it were accurately assessed, would take
an approximately equal proportion of wealth-incomes. It does not, of
course, touch directly incomes derived from wages and salaries, but it
reduces their purchasing power in many cases. It is in some respects
more searching than a tax on actual rents, for it reaches the
prospective, or speculative, rental.

(d) Taxes may be on _expenditure_ (sometimes called taxes on
consumption). This is but another mode of attacking income, for in the
long run most income is spent, not always by the individual who earned
it, but by some one, and thus it is reached by a tax on expenditure.
Usually in the United States the tariff duties are accounted to be
taxes on expenditure, as also the internal revenues (also called
excises) of the national government. In time of war, internal revenues
are extended in the United States to a multitude of articles, but
usually they have been limited (with minor exceptions) to liquor and
tobacco. Most of these taxes are in fact levied not at the time of
purchase by the ultimate consumer, but upon the specific goods in
the hands of some merchant or business agency, and some of them are
essentially special property taxes and others are business taxes of
the kind next to be mentioned.

(e) Taxes may be levied on selected agencies of industry or on the
process of _business_; such are business taxes, licenses, taxes on
investment in business, and corporation taxes. These burdens are
diffused and rest eventually on some income, rarely to be ascertained
exactly.

§ 10. #Defective tax "systems."# The actual tax laws of each division
of government in a country combine the various forms in different
proportions. Most of the federal taxes are from tariff duties and from
internal revenues; the latter include a variety of special business
and property taxes and, since 1913, the federal income tax. The
largest receipts of states, of counties, and of minor divisions are
from property taxes, some special but most of them general in form.
Among the various states a wide diversity is found. Some use the
general property tax for all the divisions (state and local), while
others (several of the Northern states and California) have separated
the sources of state and local taxation, taxing corporations for state
purposes, and most other forms of wealth for local purposes. Some
states, particularly those of the South, make large use of licenses
and taxes on business both for state and local purposes. The tax
laws of many states have been much modified of late and are still in
process of change. It is only in a loose sense that one can speak of
the tax "system" of any state, made up as it is of so many diverse
elements, each used to tap in some independent way some source of
private income for public purposes. Every tax "system" has grown up
more or less accidentally, guided by no more of a general principle
than the advice of the cynical old statesman--so to pluck the
feathers of the goose that it will squawk as little as possible. Thus,
everywhere, the existing situation must be largely accounted for by
custom and ignorance, by the weakness of some classes and the undue
influence of other classes, rather than by clearly thought out
principles soundly administered.

§ 11. #Various standards of justice suggested.# There have not been
lacking earnest attempts to arrive at some general principles. Many
standards have been suggested to measure the distribution of the
burden of taxation, such as benefit, equality, and ability. Each of
these terms is capable of various interpretations which have changed
from time to time. The benefit derived by any citizen from most of
the public services evidently cannot be measured with exactness. The
standard of equality cannot be applied in any literal sense to strong
and weak, to rich and poor. It is possible, however, to interpret
equality with reference not to objective goods, but to the psychic
sacrifice occasioned by taxation. Ability is of many kinds and may
be differently understood. Some think ability to bear taxation is
"in exact proportion to the money income"; others believe that it
increases at a greater rate than money income, and favor, therefore,
progressive taxation, that is, higher rates on the larger incomes.

§ 12. #Social welfare as the aim.# The conflicting interests of
the various classes of taxpayers in each period are to some degree
softened by the prevailing public opinion, sometimes called the social
conscience, and taxes are adjusted according to a vaguely held
ideal of the social welfare. Social expediency, more or less broadly
interpreted, determines who shall be taxed and what social results are
to be sought. The exemptions from taxation in feudal times were great
and, viewed from our standpoint, were inequitable, for the upper
classes escaped while the peasants bore most of the burdens. The
landlords and nobility, who were assumed to be performing important
social functions, generally had outgrown their usefulness in the
period preceding the French Revolution, which swept away many of these
abuses.

Exemptions from taxation are granted liberally in most states to-day
on some kinds of wealth and to some classes of citizens, because
of their supposed relations to the public interest. Real estate and
equipment devoted to educational, religious, and charitable purposes,
the homes of priests and ministers, homesteads purchased with pension
money, as well as all public lands, buildings, and equipment are
exempt.

The social interest requires that taxes be both elastic and
productive, so that the needs of the government shall be amply
provided for. The harmonizing of these needs in the laws of taxation
requires a high degree of wisdom, of foresight, and of integrity
in the legislator and in the citizen. No hard-and-fast rule for the
apportioning of taxes can be laid down. The decision must be made in
each generation by the public opinion as to what is most expedient for
the general welfare.

§ 13. #Principles of administration.# Whatever forms of taxes are
adopted, whether on property or income, whether at proportional or
at progressive rates, their justice and expediency depend largely
on their administration. Principle and practice in this, as in most
affairs, may go far apart. The administration of taxation should
be economical, certain, and uniform. Some laws are more easily and
economically executed than others. The time of collection should be as
convenient as possible for the citizen, and the mode of payment should
be the most simple. The utmost certainty is desirable as to the time,
method of payment, and amount. Taxation that, in its principle, is
variable, shifting, or dependent on personal whim and favoritism,
is despotism. But the greatest evils, in practice, result from the
failures in assessment. The assessment of taxes has to be intrusted
to men with fallible judgment, imperfect knowledge, and selfish
interests. The assessor is as near a despot as any agent of popular
government to-day. Not infrequently men of proved incapacity in every
private business they have attempted are, for partizan or corrupt
reasons, selected as assessors, and are given the power of passing
judgment on the value of millions of dollars' worth of property. Under
the circumstances, evils are to be expected, and they occur. The small
owner often is crushed under the unequal assessment while the large
owner comes lightly off. Political friends are favored, political foes
are made to suffer. Even the most honest and capable of assessors find
in the imperfections of the tax laws[6] an insuperable obstacle to
even-handed justice.

§ 14. #Shifting and incidence.# The person paying a tax into the
public treasury is not always the one whose income is reduced in
the long run. This is most clearly seen in the case of taxes paid by
middlemen. In most cases the final and regular burden of the tax is
distributed over a number of incomes. The passing on of the burden is
called the _shifting_ of the tax; the final location of the burden is
called the _incidence_ of the tax. The lawmaker cannot tell exactly
where the weight will fall. The principles of value give some guidance
in the inquiry, but the workings of the principle are difficult to
follow.

Consider a situation where certain taxes have been for some time
levied. They have become a part of the general adjustment of prices.
If paid by any one in business they may be looked upon as a deduction
from the gross proceeds or product of the business, prior to cost, or
as a part of cost.[7] In either case every one choosing that business
does so in the light of this fact. Unless the business promises to
yield as good incomes (wages, profits) as other lines, the number
engaging in it, and the output, must diminish and thus the price of
the product rise, or the cost of the factors fall, or both in some
proportion. The tax on any durative agent or on any established
business thus becomes incorporated after a time in its price and in
the prices of the products, and any purchaser pays a price based on
the net income remaining to the owner of the wealth after the tax is
paid. Viewed in this way, taxes are seen to be borne to some extent
by every one, by those who do not as well as by those who do actually
meet the tax-collector face to face. The citizen with no taxable
property is affected, far more than he realizes, by extravagance of
government and by inequities in taxation, for the effects of most
taxes are diffused so that every self-sustaining member of the
community has some share in them.

§ 15. #Taxes as costs.# Now if a new tax is levied, or an old tax
changed in amount or in its incidence, it becomes a new influence in
industry. Some occupations are made more attractive, others less so.
Some places are made more, others less, desirable to live in.
Property thus fluctuates in value, and investments become more or less
remunerative. If the new tax reduces the net income of any productive
agent, it reduces likewise its value, which is but the capitalization
of its net rental. If taxes are taken off of factories and put upon
farm rents, factories rise and farms fall in value in the hands of
their owners. The immediate change in value is much greater than the
annual tax, for if five dollars is to be taken permanently from the
annual rental of the farm, nearly one hundred dollars is taken at once
from its selling value when the prevailing yield on investment is
5 per cent. The rate of adjustment varies greatly under different
conditions, and the inflow and the outflow of labor and capital are
more or less rapid in the various industries.

Taxes that enterprisers are unable to shift to others are reckoned by
them as a part of their costs of production whenever the conditions of
competition and of substitution make it possible to do so. Every new
tax that curtails the supply of any necessary agent must raise the
price of the products and cause more or less of the tax to fall upon
the consumers. In the Civil War an increase in the tax on whisky
increased its selling price, and distillers who owned stocks on which
a smaller tax had already been paid reaped profits of millions of
dollars. When the tax on tea was increased in England, all dealers
that had accumulated a stock before the law went into effect were
gainers. Every change in taxation inevitably affects, either favorably
or unfavorably, many interests. The chance to anticipate a change in
tax laws or to get, from those in power, information of a proposed
change, makes speculation possible and political corruption
profitable.

The fact that a change in taxation is a disturbing element in price is
not to be deemed insignificant merely because "all comes out right
in the end." Every change in taxation is an element of uncertainty
in business and increases the fortunes of some men at the expense
of others. Hence no considerable change should be made without good
reasons in its favor. The older taxes have the virtue of stability,
but in many cases they have grown out of harmony with the industrial
conditions. While, therefore, from time to time there is a real need
of a reform in the tax system, it should not be undertaken without
recognizing the many and complex interests involved.

[Footnote 1: Meaning here not a certain political party, but a
principle of social action.]

[Footnote 2: The total debts of the _national_ governments of the
world just before the outbreak of the great war in 1914 were estimated
at about $44,000,000,000. (These figures include the debts of the
separate states in the federal unions of Australia and the German
Empire, and the separate debts of European colonial governments, but
not those of the states of the United States, and in no case including
the debts of minor divisions, the total figures for which are not
to be had.) The new debts created by the war give already more than
double the foregoing total.]

[Footnote 3: The special assessment is thus in its nature, in part a
private investment. The plan, of special assessments could easily be
applied in many more cases than is done at present.]

[Footnote 4: There are border-line cases where it is difficult to
decide whether a particular payment to the government in the form of a
fee, price for service (as water rates, etc.), and special assessment
(as for street paving) is in the legal sense a tax or not. Some
courts have, for example, decided that for certain purposes a special
assessment is to be called a tax, and in certain other cases it is
not to be if this would defeat the evident and just intention of the
legislature.]

[Footnote 5: The figures do not include returns from incorporated
places having a population of less than 2500 where the poll taxes may
be a considerable sum.]

[Footnote 6: Particularly the difficulties noted in the next chapter,
sees. 2-5.]

[Footnote 7: See Vol. I, p. 374.]

CHAPTER 17

PROPERTY AND CORPORATION TAXES

  § 1. Importance of taxation as a public question. § 2. The general
  property tax; nature and difficulty. § 3. Ambiguity of the term
  "property." § 4. Various temporizing policies. § 5. A consistent policy
  of wealth-taxation. § 6. Needed reform of assessment. § 7. Separation of
  state and local taxation. § 8. Federal taxation of merchandise in
  commerce. § 9. The proposal of the single tax on land values. § 10.
  Various reforms in land taxation. § 11. Difficulties in taxing
  corporations. § 12. Special taxes on banks. § 13. Special taxes on
  insurance. § 14. Special taxes on transportation. § 15. Alternative
  policies of corporate taxation. § 16. General plan for corporate
  taxation.

§ 1. #Importance of taxation as a public question.# The discussion of
taxation has accompanied the growth of free government in England and
America from the time of Magna Charta. The control of the public purse
has been found to give the key to political power, and therefore it
has frequently become the occasion of conflict between the monarch and
the people. But in our own national history since the adoption of the
Constitution, taxation has not had a leading place in politics except
in the one aspect of the tariff. The constitutional question of
states' rights long absorbed most of the interest of citizens and
of legislators. But with the quickened attention of the public to
economic questions, the problem of taxation became of increasing
importance.

It has come to be recognized that taxation can be made to play, and
is bound to play, a leading part as an agency in the distribution of
wealth, and thus it is the center of much of the ardent controversy
regarding social reform. Ultimately, almost every proposal of social
change and betterment involves some cost. The question then must be
answered. Who is to receive the benefits and upon whom and how shall
new taxes be levied to pay the cost? Further, it is often urged that
this result of taxation in redistributing incomes is in itself (or can
be made) a virtue; and some even see in tax reform the answer to the
largest social questions of our time. We are now to take up a few of
the more important problems of taxation, to see the difficulties, and
to suggest the direction in which their solution is to be sought. The
tariff having been already separately considered, the chief kinds of
taxes we have here to treat are property taxes, general and special,
and inheritance and income taxes.

§ 2. #The general property tax; nature and difficulty.# The rates both
of assessment and of levy of the general property tax are uniform and
equal in proportion to the value of all (or nearly all) property in
the taxing district.[1] There are always some exceptions of certain
kinds of property, or of the property of certain persons, or of
property and things put to certain uses--public, educational,
religious, and charitable in their nature.

The federal government levies no general property tax, but the other
branches of government[2] receive about three-fifths of all their
revenues from it.

At first view nothing would seem to be simpler and juster in principle
than such a plan of taxation, but those who have most carefully
studied its practical operation, almost with one accord, pronounce it
to be "a dismal failure." The chief reason assigned for this failure
has been that the assessment of the tax is imperfect and incomplete.
The usual thought is that if all property could be assessed the plan
would be excellent. Undoubtedly the difficulty of just assessment has
its part in the weakness of the tax, but back of, and more important
than this, is an inherent fallacy in the apparently simple principle
of the tax.

§ 3. #Ambiguity of the term "property."# Unfortunately, the word
property is applied, even by the most competent courts, both to the
intangible right of ownership (the fundamental meaning) and to
the concrete thing that is owned, the source of the income.[3] But
evidently the value of the right to the income yielded by a house, for
example, is merely the value of the house. The value of the _property
in the one sense_ (the abstract ownership, the intangible right) is
merely a reflection of the value of the _property in the other sense_
(the concrete wealth). There are not here two independent bodies of
economic wealth. Whatever value belongs to the one is subtracted from
the other. Nor is it rational to take the paper document called a deed
(which is but the evidence of ownership) and call it tangible property
having a value in addition to the house itself. Yet, in fact, all
these confusions are constantly made in taxation. The term "intangible
personal property" is applied to such things as mercantile credits,
promissory notes, bonds--in general to the right to collect sums
from another person, whether these rights arise out of sales or of
loans--and all are treated as parts of taxable property. Sometimes
the evidences of indebtedness, the promissory notes or the mortgage
papers, are even called tangible property, the same term that
is applied to land, houses, and machinery. By universal practice
supported by a long line of court decisions, these rights (whether
evidenced by paper or not) are made subject to taxation, except as
by piecemeal legislation certain grudging exceptions have been made.
These views and this practice are supported by the popular desire to
tax money-lenders. The result is "double taxation" of many sources of
income. This involves a burden that is ruinous in some cases, both to
borrowers and to lenders, and that tempts in all cases to the evasion
of the tax.

Take, for example, a house assessed at $10,000 which is owned free of
debt and which has a rental value of $600. At the rate of 1.5 per cent
the tax paid would be $150. Now if the owner borrows $8000 he is still
taxable $150 on the full value of the house, and the lender nearly
everywhere is taxable $120 on the amount of his mortgage. The total
tax payable out of the one source of income, the house, is then $270.
The same analysis will show that any credit is but a contractual
claim upon some other source of income which is, or should have been,
already taxed.

If one person owns all the capital-value invested in a specific piece
of wealth, no attempt is made to tax both the capital and the wealth;
but if it happens that two or more persons share the capital-value
invested in the same wealth, the attempt is made to tax as a unit the
full value of the wealth and, in addition, some part of the capital
also. It is, however, easy in most cases to conceal this "intangible
property" from the assessor's eyes, and a comparatively small amount
of it is ever taxed. This means inequality and hardship in the
operation of the tax and, as a result, unceasing temptation to perjury
by the taxpayer and to favoritism and graft by public officials.

§ 4. #Various temporizing policies.# The general property tax in
practice is unjust and demoralizing. What, then, shall be done about
it? Various policies have been followed. One has been to declare that
the law would be good if it could be enforced, but that as in practice
it cannot be, the best thing is to go on as before, catching a few
"tax dodgers," and letting the rest go. Another policy is to hire
"tax ferrets," paying them large commissions to discover cases
where intangible property of this sort has been concealed from the
assessors. This method, no matter how stringently applied, has never
reached more than a small proportion of the cases, and becomes a
potent agency of political favoritism and corruption.

Another policy is to maintain the general principle, but to make
exceptions here and there. Usually the exceptions are made just at
those points where the law would with earnest effort be most easily
enforceable, and therefore where it has become most inconvenient. As
a result of these changes the state laws display a bewildering and
illogical variety. By constitutional interpretation, United States
notes and federal bonds are exempt from state and local taxation;
generally, by state law, building and loan association and
savings-bank loans are exempt as, in a majority of states, are state
and municipal bonds if held within the state. In at least eight
states, bonds of the state are exempt, but those of the municipalities
are taxable, while in a few states the reverse is the case. In several
states both kinds of bonds when issued after specified dates, are
exempt, but in Ohio state bonds are exempt only if issued prior to
1913. All but seven of the forty-eight states, however, attempt to tax
the resident holders of state and municipal bonds of other states;
but the exceptional states are those in which most of the investors
in this class of securities reside. In many cases private debts
receivable are allowed to be offset against debts payable. In some
states mortgages on real estate are exempted or (in Massachusetts)
treated as an interest in the real estate. Rarely mortgages are
exempted up to a certain amount (in Indiana, to $700, the purpose
being to tempt the borrower to reveal the name of the lender).
Sometimes a special mortgage registration tax, payable but once (in
New York 1/2 of 1 per cent) is levied, and otherwise mortgages
are free from taxation. Small as this rate is, the fiscal yield of
mortgage taxation under this plan exceeds that under the general
property tax.

By the overlapping of these laws, so contradictory in principle, it
may happen that securities held by taxpayers residing in other states