“The revenue of excise would in this case, indeed, suffer a little, and that of the customs a good deal more; but the natural balance of industry, the natural division and distribution of labour, which is always more or less disturbed by such duties, would be more nearly re-established by such a regulation.” (WN, IV.iv.14)

Adam Smith turns his attention to another mercantilist trade policy in Book IV, Chapter 4 of The Wealth of Nations: drawbacks, i.e. targeted tax breaks on exports. In Smith’s day, most exports were subject to the payment of excise taxes. That is, when a merchant wants to export goods abroad, then, in the absence of a drawback, he must pay excise taxes on those goods. With a drawback, however, the merchant gets a partial or full refund on those paid excise taxes. For his part, Smith concludes that drawbacks are “reasonable” but only to the extent they promote foreign trade:

“To allow the merchant to draw back upon exportation, either the whole or a part of whatever excise or inland duty is imposed upon domestic industry, can never occasion the exportation of a greater quantity of goods than what would have been exported had no duty been imposed.” (WN, IV.iv.2)

Nevertheless, Smith also identifies two potential problems with drawbacks. One is fraud: unscrupulous exporters might try to “clandestinely” re-import or otherwise divert their tax-free goods back into the home market. (IV.iv.16) The other is monopoly: when a merchant already enjoys a government monopoly on the export of X goods, providing him a tax break on those goods is just pure payola. (IV.iv.15) In both of these cases, drawbacks reduce the amount of tax revenue the government is able to collect without increasing the overall level of trade:

“The drawback, therefore, may frequently be pure loss to the revenue of excise and customs, without altering the state of the trade, or rendering it in any respect more extensive.” (WN, IV.iv.15)

Do these costs outweigh the benefits? For Smith, the answer is, It depends. More specifically, it depends on whether the net effect of a country’s drawback policy is to increase trade. Although the original purpose or goal of drawbacks was to promote what Smith calls the “carrying trade” — i.e. the business of transporting the goods of one country to another country — drawbacks are good (in the Smithian sense) to the extent they leave the carrying trade free:

“Drawbacks were, perhaps, originally granted for the encouragement of the carrying trade, which, as the freight of the ships is frequently paid by foreigners in money, was supposed to be peculiarly fitted for bringing gold and silver into the country. But though the carrying trade certainly deserves no peculiar encouragement, though the motive of the institution was perhaps abundantly foolish, the institution itself seems reasonable enough. Such drawbacks cannot force into this trade a greater share of the capital of the country than what would have gone to it of its own accord had there been no duties upon importation. They only prevent its being excluded altogether by those duties. The carrying trade, though it deserves no preference, ought not to be precluded, but to be left free like all other trades. It is a necessary resource for those capitals which cannot find employment either in the agriculture or in the manufactures of the country, either in its home trade or in its foreign trade of consumption.” (WN, IV.iv.12)

So, why does Smith defend drawbacks at all? Why not call for getting rid of excise taxes altogether? After all, we wouldn’t even need give exporters tax breaks (i.e. drawbacks) if there were no excise taxes in the first place! For me, the answer is clear: because what this chapter goes to show is that Adam Smith is no ideologue or zealot. He is a pragmatist who is able to judge any given mercantilist policy on its merits, by weighing both the costs and the benefits of the policy. (To be continued …)