Thursday, July 25, 2024

Can We Replace The Income Tax With Tariffs?

Former President Donald Trump created a stir recently when he proposed replacing the income tax with tariffs. Trump made the stunning proposal in a meeting with Congressional Republicans. If Trump wins reelection in November, Republicans will be looking for a revenue source to “pay for” the extension of his tax cuts when they expire in 2025.

Predictably, the left panned the proposal. The far-left Media Matters did a roundup of media hits criticizing the proposal. On Sunday, Treasury Secretary Janet Yellin piled on attacking Trump’s idea as harmful to working-class Americans and American businesses.

From a historical perspective, Trump’s tax proposal is not completely insane. In fact, it would be a tax structure that our Founding Fathers would recognize. Before the creation of the income tax in 1913, the federal government was mostly funded through tariffs. The problem is that after the creation of the income tax and the Federal Reserve, the federal government grew massively. 

The first question that needs to be answered is can the income tax be replaced with tariffs? The critics of Trump’s proposal are right when they say the math doesn’t work. 

In the last fiscal year, the federal government collected $2.2 trillion in income taxes. In contrast, the federal government only collected $80 billion in customs and tariffs. 

In 2022, the U.S. imported $3.9 trillion worth of goods and services. Tiana Lowe Doescher of the Washington Examiner estimated that the tariff rate would have to be 56%. But services would be very hard to levy a tariff on. Also, consumers would likely switch to American-made products, which would become cheaper. So the tariff rate would have to become higher over time and it would be more difficult to maintain a consistent revenue source. Suffice to say, the math doesn’t work for the proposal.

Tariffs, whether used for revenue or to protect industry, come with drawbacks in addition to their ability to generate revenue. When the U.S. government imposes tariffs, other countries would likely retaliate with their own tariffs on American companies. The American economy would be hammered with the double whammy of higher costs for American consumers, who would pay the tariffs at the end of the day, and less business for American exporters.

Trump’s proposal to Congressional Republicans may not be a workable proposal but it is still a valuable tool to get a conversation started on eliminating or deeply cutting the federal income tax. An income tax is a penalty on working and saving. America has a really low savings rate, which is a major cause of our record trade deficits. 

The American economy would be better off if we replaced the federal income tax with a consumption tax such as a national retail sales tax. It would encourage Americans to save and work.

Currently, around 40% of income tax filers do not pay income tax (they pay payroll taxes though) and that does not include people who work “under the table”, the millions of foreign tourists who come to the U.S. every year, and the growing population of illegal aliens. A national sales tax is a way for all Americans and for foreigners to help fund the federal government.

One of the criticisms of a national sales tax is that it is too regressive and would harm the poor and middle class. But it could be structured in a way to exempt items like food and medicine and there could be “sales tax holidays” on other items at certain times of the year as many states do. The point is, a national sales tax can be structured to limit the harm to poor and middle class Americans.

There’s even a place for tariffs in the economic policy toolkit. They can be used a trade enforcement mechanism to ensure fair trade between the U.S. and other countries.

Finally, there is a sure way to reduce the revenue needed by the federal government and that is to dramatically shrink its size. “Starve the beast” doesn’t work because of the federal government’s ability to borrow money that has to be eventually paid back. Congress has to bite the bullet to actually reduce the size of the federal government.

Trump’s proposal is not a realistic plan but what it should do is start a conversation on getting rid of the federal income tax and get federal spending under control.