The roots of globalization, which has defined the world economy for at least the last 30 years, extend far back. Along with improvements in logistics and the spread of capitalism, the recipe for globalization called for reductions in tariffs and other trade barriers. Already in the mid 19th century, tariff barriers were coming down across wealthy countries. In Europe, the enactment of dozens of trade agreements between countries, most-notably the Cobden–Chevalier Treaty, had reduced tariffs substantially by the 1870s.
However, the United States was absent from this trade liberalization project. Whereas tariff rates in Europe had come down to well below 10% by 1975, and often below 5%, they were rising precipitously in America. It was not until the early 20th century that the US joined in on the free trade trend and reduced tariff rates to such low levels. Key in bringing this about was the creation of the income tax and the Revenue Act of 1913, which had perhaps an even larger impact on public finance than it had on trade.
American Protectionism
In the nation’s early history, tariffs were thought of primarily as a vital source of federal revenue rather than as a tool for protecting industry. This did not mean that tariffs were low though and indeed they rose steadily in the early 1800s. Tariffs levied on imported goods spiked in 1816 especially; part of the reason was that the motivation for taxing imports began to change. Rather than being thought of like any other tax, as a necessary evil (the US was formed in a tax revolt after all), tariffs were increasingly being seen as a tool for protecting domestic industry. The Tariff Act of 1816 for example, was passed with an explicit intent for protecting industry, especially the textile business, as well as merely raising revenue.
However, these tariffs along with others passed in the 1820s, began to tear the country apart. As the average tariff collected as a percentage of imported goods’ value hit 50% in the late 1820s, the effect was being felt unevenly across the country. In the north, with its burgeoning industry, the protective tariff was popular; in the south, which was overwhelmingly agrarian, it was not. Southerners saw tariffs as excessive and unfair consumption taxes; as far as they were concerned, they were subsidizing northern industry through higher prices. This was made all the more problematic since the federal government was no longer using such tariffs to simply raise necessary revenues but had protectionist motivations. The result was that such taxes were set at punitively high levels beyond those needed to simply fund the state.
The debate over the protective tariff culminated in the Tariff of 1828, the so-called “Tariff of Abominations.” This led to the infamous Nullification Crisis of the early 1830s, when the State of South Carolina unilaterally declared the tariffs unconstitutional, threatened to ban their enforcement in the state, and contemplated secession. To de-escalate the crisis, President Andrew Jackson backtracked and passed the Tariff of 1833, which gradually reduced tariffs closer to the levels needed to merely fund the government. The average tariff rate retreated back down to around 20%.
A major tariff reduction in 1857 was the last hurrah for trade liberalization for decades to come. The election of Abraham Lincoln on a pro-tariff platform, the Civil War, and the resulting domination of both Congress and the Presidency by the Republican Party led to a sharp increase in tariffs in the 1860s. Though they would not rise as high as the tariffs of the 1820s, they sought to provide protection to a wider array of industries as industrialization picked up pace after the war.
The economic doctrines that encouraged high tariffs remained politically dominant through the late 19th century. This so called “American School” of economic thought held that high tariffs protected not just established industries but also the American worker. Proponents argued that liberalized trade would reduce wages as industry cut costs to match the prices of cheaper foreign goods. They insisted protection kept wages high, making up for the higher cost of goods faced by consumers.
“Whether a thing is cheap or dear depends upon what we can earn by our daily labor. Free trade cheapens the product by cheapening the producer. Protection cheapens the product by elevating the producer.” – US President William McKinley, 1892
Meanwhile, supporters of free trade pointed to Britain, where both wages were high and goods were cheap, as evidence of the fruits of free trade. Regardless, while tariff reforms tweaked taxes on imports over time, high tariffs remained in place until the early 20th century. The fiscal needs of the state meant there was a floor to how low tariffs could go. The creation of the income tax, however, would change this and allowed tariffs levied in the US to converge with the norms of other industrialized countries in Europe.
Revenue Act
The federal government had been funded primarily by excise taxes and customs duties since the country was founded. Despite a short-lived income tax during the Civil War, this remained the case up until the 1910s. However, the newly elected President Woodrow Wilson, made tariff reform a priority in 1913 and rather than envision a modest tariff reduction; the new administration and its congressional supporters set about overhauling the American federal government’s finances altogether.
The Revenue Act of 1913, also known as the Underwood Tariff, was a major pivot in American trade policy; the protective tariff was on its way out. Tariffs were reduced on hundreds of items and in a few short years the average tariff as a percentage of imported goods’ value was reduced from 20% to nearly 5%. Crucial to making such a reform possible was the income tax. Income taxes had existed previously, such as during the Civil War, but were ruled unconstitutional by the Supreme Court in 1895 after a past attempt at establishing one. The ratification of the Sixteenth Amendment to the Constitution finally enabled the income tax to serve as a core source of government revenues, removing the fiscal need for customs duties altogether.
Trade and Public Finance
It is difficult to make conclusions about the tariff reduction’s effects on trade, largely because the disruptions caused by the First World War obfuscate any natural results of the law. Trade volumes actually fell in the year following the tariff cut, which was the year war broke out in Europe. Trade then surged as the US supplied Europe’s belligerent nations with weapons and other commodities and goods. It is also clear that future tariff increases such as the infamous Smoot–Hawley Tariff, which reversed much of the tariff reduction of the Revenue Act, did result in sharply reduced trade and is considered a factor in exasperating the economic slump of the 1930s.
Nonetheless, the Revenue Act undeniably did transform American public finance. From 1910 to 1920, the American federal government went from being largely funded by ad valorem taxes, namely excise taxes and tariffs, to one overwhelmingly financed by income taxes.
To be sure, some of this was the effect of the prohibition of alcohol, whose taxation previously provided a large fraction of government revenues. However, the sharp reduction in tariffs and the creation of new taxes on corporate and individual incomes as well as inheritances were transformative as well. While tariffs were raised in the 1920s and 1930s, they would never again rise to the levels seen during the 19th century. Whatever its immediate impact was, the Revenue Act removed a major impediment to free trade. No longer would tariffs need to be raised for the purpose of financing government expenditures; going forward the protective tariff in America would live or die on the relative merits of free trade versus protectionism.
Lesson
If asked to judge which decade saw the greatest transformations in the American economy, the 1930s often comes to mind first. Besides the decade of President Roosevelt’s New Deal, the 1980s may also stand as a compelling candidate for that title. However, along with these obvious contenders, the decade spanning from 1910 to 1920 has a compelling case as well. In American industry, it was the decade of scientific management (often known as Taylorism) and the assembly line. The 1910s was also the decade that saw the creation of the Federal Reserve. All this is in addition to the strides made towards trade liberalization in a country that hitherto stood firmly behind protectionism. If the United States was to become a nation advocating for freer trade and partaking in it as well, the Revenue Act was crucial to making it so. This transformation was just another in the story of the gradual advancement of free trade in the modern era.
Further Reading
1. Chantrill, Christopher. “Government Revenue Details.” US Government Current Revenue History with Charts.
2. Crane, Charlotte. “How the 100-Year Old Income Tax Unleashed the Modern U.S. Economy.” The Atlantic, Atlantic Media Company, 25 Feb. 2013.
3. Kopf, Dan. “The History of US Protectionism, in One 230-Year Chart.” Quartz, 16 Mar. 2018.
4. Smith, Ryan P. “A History of America’s Ever-Shifting Stance on Tariffs.” Smithsonian.com, Smithsonian Institution, 12 Apr. 2018.
5. Thorndike, Joseph J. “The Income Tax Arrives.” Tax History Project, Tax Analysts.
