NYT (“Trump Flirts With the Ultimate Tax Cut: No Income Taxes at All“):
Former President Donald J. Trump has spent much of the presidential campaign brainstorming new, and sometimes untested, ways to cut taxes. In the election’s final stretch, he raised the possibility of going even further: eliminating income taxes entirely.
During a Fox News segment on Monday, Mr. Trump took questions at a barbershop in the Bronx. When asked if the United States could potentially end all federal taxation, Mr. Trump said the country could return to the economic policies in the late 19th century, when there was no federal income tax.
“It had all tariffs — it didn’t have an income tax,” Mr. Trump said. “Now we have income taxes, and we have people that are dying. They’re paying tax, and they don’t have the money to pay the tax.”
In June, Mr. Trump floated the idea of replacing federal revenue from income taxes with money received from tariffs. Mr. Trump has not provided specific details of how that would work, and it is unclear if he wants to eliminate all federal taxes, including corporate income taxes and payroll taxes, or only end the individual income tax.
So, let’s stipulate: Trump is not a policy guy and, even by Trump standards, it’s not quite clear what he’s proposing. That said, he’s made reference to this idea repeatedly, either because he thinks it’s a good one, because he thinks it’ll resonate with voters, or both.
The obvious retort is that we started replacing a reliance on tariffs with a system of income taxation more than a century ago for a reason. Indeed, Congress considered doing so way back during the War of 1812 and did so during the Civil War. The Supreme Court, likely correctly, ruled that Congress lacked the Constitutional power to levy a tax on income in 1895, but eventually, a bipartisan consensus that one was necessary was reached and the 16th Amendment was passed through a two-thirds vote for both Houses of Congress and ratified by the requisite three-quarters of state legislatures.
As we’ve discussed many times before, the Framers intentionally made it quite difficult to amend our foundational document. But it had long since become clear that tariffs simply don’t provide enough revenue to fund a modern government. Further, they’re incredibly regressive.
As a July brief from the White House Counsel of Economic Advisors (“Tariffs as a Major Revenue Source: Implications for Distribution and Growth“) explains:
Tariffs have not provided a meaningful share of revenue for the US government since the early 1900s (see Figure 1a). Existing imports duties on goods raised $80 billion last year, about 2 percent of the $4.44 trillion in total Federal tax revenue (Figure 1b).[1] By comparison, the individual income tax was responsible for 49 percent of total Federal tax revenue, and an additional 36 percent was raised via social insurance (payroll) taxes, which are closely tied to individual income. In other words: more than three-quarters of federal tax revenue is linked to individual wage and non-wage income.
But this is circular, right? We bring in comparatively little in tariffs because we have low tariffs and high income taxes, right?
Not so fast, my friends.
It is mathematically unlikely that a broad tariff could ever replace the revenue raised by the individual income tax. For example, given the value of goods imports during FY2023 ($3.12 trillion), an across-the-board 70 percent tariff would be required to replace the equivalent revenue raised by the individual income tax under the overly simplistic assumption that consumers, producers, and our trading partners would have made no changes to their behavior in response to the tariffs. There are several reasons to believe, however, that this “static” exercise is a substantial revenue overestimate.
Ah, but that’s great, you say. After all, income taxes are paid by hardworking Americans like you and me, while tariffs are paid for by greedy foreigners (“FUR-in-urs”).
First and foremost, an across-the-board tariff is likely to spark retaliatory tariffs that reduce U.S. exports and subsequently induce transfers of collected duties to impacted U.S. businesses. For example, U.S. farmers facing retaliatory export tariffs during the 2018-2019 trade war received Federal subsidies that totaled 92 percent of the collected duties. Thus, even in the context of targeted tariffs impacting a relatively small fraction of overall imports, the Federal government ultimately collected only 8 percent of the tariff revenue. As the scope of this tariff increases, the scale of retaliatory tariffs and cost of offsetting subsidies for affected businesses is likely to increase. Moreover, consumption and production patterns are likely to respond to avoid the expense of this tariff, further reducing expected revenue. As a result, across-the-board tariff rates would likely need to be much larger than 70 percent to raise tax revenue that is equivalent to the individual income tax.
Further, this type of across-the-board tariff is likely to negatively impact the US macroeconomy. To begin, these tariffs will raise the prices of imported consumption goods and imported inputs used to produce output that is sold both domestically and internationally. A recent study found that a broad implementation of tariffs would raise the inflation rate by about ¾ percentage point relative to the current baseline (Zandi, Le Cerda, and Begley 2024 and correspondence with author). Clausing and Obstfeld 2024 concur that the inflation impact of an across-the-board tariff would be severe.
Okay, fine. But we can just quit buying crap from China (JIE-nuh) and start making things in the good ol’ US of A.
Crucially, the increase in imported input prices adversely impacts the efficiency of domestic production. Indeed, the evidence shows that large-scale tariffs result in significant declines in domestic output and productivity, higher unemployment, more inequality and real exchange rate appreciation implying a loss of international competitiveness, while having only small effects on the trade balance. Any increases in interest rates to combat transitory inflation due to rising prices will be contractionary, additionally contributing to a decline in real investment and output. These cumulative effects are likely to further depress the revenue raised by an across-the-board tariff.
This, apparently, involves some math. So, let’s move on.
Finally, relying on a tariff as a major source of tax revenue raises serious equity concerns. As noted, across-the-board tariffs would cause substantial pressure on consumer prices, either because consumers directly purchase imported goods or because businesses that rely on imported goods as inputs to their production increase prices. Because lower-income households spend a larger share of their income on consumption of these goods, they will be disproportionately burdened by a broad tariff. For example, CEA estimates indicate that introducing a 10 percent across-the-board tariff would impose a tariff burden of 2.3 percent of income for those in the bottom quintile compared to just 0.5 percent for households in the top 1 percent, following the methodology employed by Clausing and Lovely (2024)
Yeah, but 2.3 percent is great compared to the, what, 70% they’re paying in income taxes now?
In summary, they conclude:
Strategically targeted tariffs are an important tool to protect economic and international interests of the U.S. However, the potential for a broad tariff to serve as a major revenue raiser in a modern, global economy is limited. Moreover, elevating the reliance of the Federal government on tariff revenue would likely exacerbate long-running trends in income inequality by shifting more of the burden of taxation onto lower-income households. It is also highly like to generate large, negative distortions to the macroeconomy.
The NYT report reminds us that the income tax itself has changed a lot from its earliest days:
At first, it was narrowly targeted at wealthy individuals and corporations, but fighting two world wars and creating programs like Social Security was expensive. American policymakers turned to income taxes to pay for those priorities.
“It becomes a mass-based income tax for the first time during World War II,” said W. Elliot Brownlee, a historian of tax policy at the University of California, Santa Barbara.
Tariffs dwindled as a source of federal revenue while income taxes expanded. Today, tariffs make up just 2 percent of federal revenue, while income and payroll taxes make up about 94 percent. Overall, the tax system is progressive: In 2020, the top 20 percent of earners in the United States paid about 80 percent of all federal taxes, according to the Congressional Budget Office.
Whether the rich pay their “fair share” of taxes is infinitely debatable. But, currently, they pay the lion’s share of federal taxes. (Unlike most calculations, this explicitly includes Social Security taxes, which are actually somewhat regressive.)
