Writing at De Hoover Institations Define publication (“Clean up the air for rates and shortages“April 24, 2025), co-blogger David Henderson mentions two plausible arguments for a non-no-out rate. One is within an optimal tax regime:
Another intellectual respectable argument for rates is that they are part of an optimal tax structure. Our federal government taxes many things: individual and business income, power gains, raw materials such as gasoline, etc. How can we be sure that a positive tax rate on input is not part of an optimal tax system? We can’t. We do know that the deadweight loss, the total loss of the tax minus the profit for the government, is proportional to the square of the tax rate. For example, the doubling of a tax rate quadruples the loss of deadweight. It may therefore be true that lowering the top marginal tax rate on income from the current 37 percent to 35 percent, for example, and replacing a 5 percent tax on import can reduce the total loss of deadweight.
I want to expand David’s discussion and discuss what I think a unique aspect of rates is that makes them more than just a different burden. But first it is worth using this opportunity to dispel a common myth over free markets and free trade. Free markets do not mean zero taxes (including rates). Instead, free markets means for me non-destructive Taxes. In other words, taxes must try to make income as neutral as possible. All taxes certainly have a number of distortion effects, but the goal is to minimize them as much as possible. To put it in Adam SmithWords (emphasis added):
All preference systems or restraint, Therefore, completely removed, it settles obvious and simple system of natural freedom of itself … The sovereign is completely released from a duty, in the attempt to perform that he must always be exposed to countless delusions, and for the right performance of which no human wisdom or knowledge could ever be sufficient; The duty to start the industry of private people and to lead it to the work that is most suitable for the importance of society (Wealth of nationsBook IV, chapter IX, section 51, pg 687).
Smith would continue in Book V (chapter 2) to determine his maximum tax, which would (in his theory) lead to minimal disruptions:
- taxes must be proportional,
- Taxes must be certain and not random,
- Taxes must be levied at a time that the payer is useful to pay it, and
- Taxes must be artificial to take as little as possible.
(He adds protective rates to this last point as a clear violation of this rule).
So, to quickly complete this expansion: free markets do not imply taxes. A government can co -exist with a free market. Similarly, rates can exist next to free trade. What makes taxes and rates bad is when they are deforming and non-neutral. That is, when they try to focus the economic activity of people.
Now, back to the main subject: rates are unique under taxes.
The vast majority of taxes is purely domestic. However, rates have been imposed on imports. So they are international. With domestic taxes is how they can be observed by other governments is not relevant (unless you have a leader who does not understand the tax, such as when they believe that a VAT is an export subsidy). However, rates can be seen as a political threat, even if they are not intended as such. It is then possible that the government takes revenge from another country, which shows a tax that would otherwise be optimally sub -optimal.
This threat of retaliation has indeed been discussed for a long time as a fundamental problem of optimum rates. In his article from 1987 ““Classic and neoclassical roots of the theory of optimum rates‘Thomas Humphrey notes that even initial theoretisers of the optimum rate (such as Js -mill) State that a great failure of other countries names (see page 27).
A theoretical optimum rate can therefore be practically sub -optimally if it is misinterpreted by other governments. The same threat does not exist with domestic taxes.
In a slightly different context, Edwin van de Haar writes about a safety dilemma between countries (emphasis added):
In a world without a highest authority, all states are confronted with a security dilemma (Booth and Wheeler 2008). This means that they cannot count on the existence of a stable and peaceful order, even if such an order were best for general human well -being. There is always the threat of a state, or a group of states, who benefit from the absence of a global government. The security dilemma is therefore existential. States must take care of their own safety, in the first place militarily, if they want to survive. Leaders and elites can never be sure about the intentions of leaders of other states, even when they do not intend to harm another state. In the same spirit, weapons that are obtained purely for self -defense can be considered offensive by others. Perceptions are important in a world of uncertainty (Human Nature and World Affairs: an introduction to classical liberalism and international relationship theorypg 78).
Consequently, a nation that builds his army for self -defense can accidentally on one more Threat of invasion if the structure is not understood by other governments.
We can see the same dilemma with rates; Call it one tariefilemma. A rate can be part of an optimal tariff plan, but if it is misused by foreign governments as an aggressive action, such an optimal rate can invite retribution, making the optimum rate sub -optimal. As is often the case with such a policy, we then see an increase in rent seeker and lobbying as domestic companies trying to get subsidies or protection against these resources, so that we add more distortions to the system. [1]
Taking into account all these political distortions, it may be that the optimum rate is indeed 0%. To build on the example of David cited above, absent retribution, a rate of 5% with a 35% top marginal tax rate can be optimally absent rate delay. But if there is retribution, this may be the case that the 37% without a rate is actually optimal.
At the end of the post, David asks why the Trump government did not try to justify rates as part of an optimal tax system:
Surprisingly, I have not seen any of Trump’s economists who encounters this case. Perhaps that is because this would be to admit that rates are taxes and that taxes impose costs on those who are taxed. Is it just possible that Trump wants his supporters to be just as ignorant of the rates when the Maga Dairy Farmer was in the state of New York?
Since David wrote those words, the administration and its allies have began to admit rates impose costsAlthough the messages are not consistent. And I don’t agree with his assessment either. There is always an incentive to cover up the costs of political projects.
But let me introduce another reason why the “optimum rate” discussion did not appear: The Trump government is open and shameless mercantilist. The repeated attacks on trade shortages indicate that the tariff plan of the Trump government is aimed at distortion goals, not on any form of optimum taxes.
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[1] On a related comment, Dom Pino that writes Lobbying rose around 277% last year due to rates. The man who “wanted to drain the swamp” makes it deeper