Should Australia retaliate to tariffs?

Is it time to bring out the DST?

With the Budget coming up I was thinking about whether tariffs or some other cross-border instrument might show up - especially given the limited fiscal headroom announced in the pre-Budget address.

I’m sure we’re all sick to death of talking about tariffs. It has reached the point where people are saying we should stop talking about the economics of it and recognise it is a cultural war issue.

Well I am going to talk about the economics of it, and try to give some advice of what we should do in this situation.

As a side note a lot of people told me that Australian article was not good and would make me angry as an economist - but I actually found it quite reasonable. He wasn’t saying that the economic consequences don’t matter, but instead that the choice was being made on the basis of a vengeful intention of a certain group independent from broad economic consequenes.

The situation in the US is insane and this appeared to just point that out.

Anyway, to my post!

tl;dr Don’t do “tariffs” back as they will largely fall on domestic consumers. Instead the US actions legitimise the introduction of a digital services tax in both Australia and New Zealand - with a related tax credit for domestically based firms. This incidence of this tax will only fall on US digital companies - the same companies that are willing to sell out democracy for a few dollars in any case.

Side note: Even given this argument I have big concerns about a DST or any transaction tax - but if the choice is that or tariff retaliation I would lean towards a DST.

I’ve heard enough from economists

Yes yes, but since you are here now lets have a chat. The US has imposed tariffs on Australian steel and aluminium. Beef and wine will come. As will further attacks on the domestic treatment of IP and medicine.

Nothing will stop these as Turnbull has pointed out. The US government and likely most of the public have convinced themselves they are the victim - even though they have the highest incomes in the world, receive favourable loan terms, and have received pretty ridiculously long IP terms from the rest of the world.

Trading with a society that is plagued with such a strong victim mentality that it appears the country is under a form of mass hysteria will create risks, and no actions taken in Australia will change what they will do.

But applying counter tariffs are fundamentally not in Australia’s interest.

This is not because some group of braindead individuals in the US will retaliate in someway - but because the incidence of the tariff will fall on Australian consumers.

Lets return to our advanced modelling software to describe this, Microsoft Paint. Take a situation where we are importing a product, and then lets introduce a tariff - what does it look like?

Beautiful. The red line is the domestic demand curve, the blue line is the domestic supply curve. Where they cross is the price without trade - which is a lot higher than the prices we are looking at.

The grey line is the world price without tariffs. The green line is the world price with a tariff. The idea here is that, if we introduce a tariff we are a small open economy - so US exporters will just go huh and sell elsewhere if a tax is applied. As a result, the price rises by the full tariff.

In other words, the US producer will sell in a market until the prices between markets equalise - if we introduce a tariff the pre-tax price will need to rise until the post-tax price the exporter receives is the same as it would have been without the tariff.

This higher price leads to domestic producers making a bit more (the shift from A to B), and domestic consumers purchasing a bit less (from D to C). But the full burden of the tax is on our dear consumers who keep buying.

Hence, introducing a tariff is just cutting off our own nose to spite our face - it is not something we should consider.

So we just do nothing

The United States has made a decision to blow up the rule based order. I have no interest in “blaming Trump” - there are enough individuals in the US both voting for him and and supporting his actions. Supported by a media that has accepted letting democracy die in darkness.

One person doesn’t have power, it is the US public who is responsible for this. If Australia and New Zealand were to go the same way, Australian’s and New Zealander’s would also be pathetic losers who see themselves as perennial victims, and are scared on their own shadow when they walk outside. As most of the US is right now.

In this context, the standard rules that Australia and New Zealand have held to in order to foster cooperation are simply not necessary, and we are well within our rights to apply legal and tax rules that we believe maximise the welfare of Australians.

Now there is something where the legislation has likely already largely been drafted in Australia and New Zealand and where other countries have already applied such a policy. A Digital Services Tax (DST).

Why a DST and not a tariff?

The incidence of a DST does not fall on consumers in a country - it falls on the margin of the digital service provider.

How? This is a tax on the revenue generated by a digital service in a country. So the price should go up like with a tariff right? No.

In our example above, the US producer had a good and they wanted to sell it - after the tariff is introduced they will simply sell it somewhere else unless the Australian consumer pays the tariff.

But with digital services we would apply this to consumption that is non-rival - if I use facebook it does not mean less facebook can be sold to others, if I watch a movie on Netflix it does not stop Netflix being available for another purchaser. As a result, taxing the revenue of a digital service does not lead to the service being sold in another market - as long as the revenue earned is positive the digital provider will stil sell it.

This difference means that a DST simply reduces the margin earned by digital service providers and does not change the quantity sold - so all that happens is Australia makes some tax revenue.

Note: There is a limit as the provider will need to meet its fixed cost to be in the market, so if the tax rate was too high the provider may simply exit - outside of full provider exit the incidence falls entirely on the company.

Now a big concern about proposals across Australiasia is the double taxation of domestic firms who provide digital services within the country (ANU TTPI) - although this did not stop the Digital Services Tax bill in NZ in 2023.

But what do you know - the US has now overruled the WTO on everything to introduce tariffs! As the key reason why a DST had to be applied on both domestic firms as well as international was the WTO, it is actually quite simple to just exclude domestically headquartered firms - rather than using some weird de-minimus to do it by stealth.

But surely the services will pass it on due to market power?

Market power means that service providers are already maximising their profit in a jurisdiction at current prices. While the near zero marginal costs implies that prices and revenue are equivalent. As a result, even with a tax the “profit maximising” price is the same price!

Market power generates the rent that is being taxed by the DST - implying the tax on that rent is earned where it is extracted, rather than in the US.

Now these providers will lie to us that we are paying the tax. They will increase the price immediately. They will itemise it on bills. They will buy ads and pay unprincipled economists to tell everyone this is the case - because it is in their interest to not have their profits taken away. This is not a conjecture, I have had providers directly admit this to me - stories I will not go into any further to protect confidence.

And in a horizontal equity sense it is a bit “unfair”. These firms are getting double-taxed.

In a rules based order such tax instruments would not be used. Concerns that digitalisation is eroding tax bases in destination countries would be considered through other means.

Current uncertainty will pass, we should ride it out

I have sympathy for this. But unless a number of individuals in the US take responsibility and stand against authoritarianism then we are not returning to the old order.

And it is largely US digital companies who have done everything in their power to help this order break down.

My apologises if you find this post overly negative about these companies and the US. However, I would not take back a single word I’ve written above.

Through the 1990s and even during the last US administration, people in the US were willing to bemoan the lack of voice for specific groups - and demand that we take the power back. But as the US walks into authoritarianism - without the excuse of a recession or an especially difficult last few years for most - the same groups are either silent or supportive. In a generation’s time the shame their children will have for their actions is incalculable.

In Australia we do not face this. But we also no longer need to keep making choices that benefit the US in order to support the rule based order that does not exist. So lets consider putting a DST in place.