Tariffs and Enforcement

People really seem to hate complicated tax codes. The dislike for a complicated tax code seems sufficiently pervasive that politicians often feel the need to promise to reduce the complexity. Yet, for all this talk, things rarely get simplified. Why is that?

One common response to that question is that politics is messy. Some might argue that well-intentioned politicians simply find it too difficult to change things. When they get into office and try to change the tax code, special interests show up with promises in exchange for upholding their particular loophole. Others might contend that the politicians are simply engaged in cheap talk. They say what they need to say to get elected, but they have no intention of actually doing anything.

These explanations are sometimes correct. Politicians do engage in cheap talk. Politicians do succumb to special interests. However, these aren’t the only possible explanations. Those who have long read Economic Forces probably know by now that I’m willing to concede these explanations, but only after looking for an economic explanation. After all, durable policies and institutions call out for explanation. Why have they survived for so long? What purpose do they serve?

Consider a simple example. Suppose that a state has an army. The army is large and the state spares no expense in funding it. The army not only provides defense in war, but is a potential deterrent to war. If the army is a good deterrent, decades might go by without a war. The absence of war might convince some that the army is a waste of money. After all, they never fight. Of course, if those people succeed in getting rid of the army, they will discover its purpose.

Can we apply the same logic to policies and institutions? Can we apply the same logic to the tax code?

I think that the answer is often “yes.” Sometimes, even unpopular policies or those that seem arbitrary can be understood with proper economic reasoning. Today, I would like to discuss one such argument, drawing on some recent research on the U.S. experience with tariffs and how they relate to state capacity by Erik Madsen, Martin Rotemberg, Sharon Traiberman, and Shizhuo Wang.

Some Initial Background

In the early history of the United States, revenue was primarily generated by tariffs. One reason that the U.S. relied so heavily on tariffs and why many developing countries do today ...