Here’s a long letter to a college student, Will Esposito, who is a regular reader of Cafe Hayek:
Thanks for your e-mail.
You’re correct that the conditions necessary for so-called “optimal tariffs” to work are far too unlikely to make the theory applicable in reality. As summarized by Thomas Humphrey , optimal-tariff theory “assumes unrealistically (1) that foreign countries will not retaliate with tariffs of their own, (2) that elasticities of supply and demand in foreign trade are not so large in the long run as to render the tariff ineffective, (3) that the optimum tariff rate can be precisely identified and skillfully administered, and (4) that politicians can resist pressures to raise tariff rates above the optimum level” – all these in addition to the assumption that the home country does indeed have monopsony power in buying the tariffed imports.
(The unrealism of these assumptions led Francis Edgeworth famously to write  that “the direct use of the theory [of optimal tariffs] is likely to be small. But it is to be feared that its abuse will be considerable. It affords to unscrupulous advocates of vulgar Protection a particularly specious pretext for introducing the thin edge of the fiscal wedge…. Let us admire the skill of the analyst, but label the subject of his investigation POISON.”)
There is, however, at least one additional assumption, too-seldom mentioned, necessary for an optimal tariff to ‘work.’ It’s this: the extra revenues the home-government reaps from the tariff are not only larger than the welfare losses that the tariff inflicts on home-country consumers; these revenues also somehow bestow a benefit on home-country consumers at least large enough to offset the losses these consumers suffer because of tariff-induced higher prices and reduced access to imports.
Analysts typically conclude that, merely because Jones and Smith are citizens of the same country, if Jones’s gains from the tariff exceed Smith’s losses, then the tariff “benefits” the country. I reject this conclusion; it’s ethically unsupportable.
To see why, suppose that Jones is your next-door neighbor on the east side of the street. Upon observing how many turnips you buy from Williams who lives on the west side of the street, Jones pulls out his gun, points it at you and Williams, and demands – in exchange for his not shooting you both – an “optimal tariff” on your purchases of Williams’s turnips.
Assuming that Jones’s tariff really is “optimal,” the loot that it bestows on Jones will exceed the dollar value of the losses that you suffer as a result of being a buyer of Williams’s tariffed – and, hence, now higher-priced – turnips. And so according to optimal-tariff theory, while the west side of the street is indeed made worse off, the east side of the street is benefitted from this optimal tariff.
Yet clearly you are not benefitted. You are harmed. Unless anyone can explain how you, in this scenario, benefit from Jones’s turnip tariff merely because you happen to live on the same side of the street as does Jones, I see no reason to classify “optimal tariff” theory as an exception to the case for a policy of free trade.
A clever supporter of optimal-tariff theory might insist that the difference separating my hypothetical from the real world is that, in the real world, you share a government budget with Jones. In principle (so says this supporter), Jones, as a government official, can use the revenues he reaps from the tariff to reduce your tax burden by more than the burden that you as a consumer endure through the tariff.
Overlooking the immorality of one group of people robbing another group of people, it is supremely unbelievable that real-world governments would not only have enough information to scientifically apply optimal-tariff theory, but also that they would routinely distribute the proceeds of these tariffs to each and every citizen in proportion to each citizen’s losses from the tariff.
In reality, the so-called theory of the optimal tariff is no more an exception to the case for a policy of free trade than is the possibility that a giant fluffy balloon randomly rolling down 34th Street will break your fall from the roof of the Empire State building an exception to the case for a policy of not leaping off of skyscrapers.
Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030