In next week’s edition of the Washington Examiner magazine, I will have a comprehensive analysis of former President Donald Trump‘s rumored proposal to replace our current income tax scheme with tariffs on imports, but before explaining a position for or against the plan, it’s important to explain the math at play here.
In the last fiscal year, the federal government collected $4.4 trillion, a whopping $2.2 trillion that came just from federal income taxes. Another $1.6 trillion came from payroll taxes, $420 billion from corporate income taxes, and just $80 billion from customs or tariffs. This revenue totaled 16.5% of America’s gross domestic product, on par with the 16.6% average from 2003 to 2022.
Federal outlays amounted to $6.1 trillion, $3.8 trillion of which was mandatory spending, entitlements such as Social Security and Medicare. Another $1.7 trillion was spent on discretionary spending, and while we only spent $700 billion paying off our interest on the $35 trillion national debt, we’re on pace to spend a minimum of $1.2 trillion on interest this year thanks to bond market panic over Bidenomics and persistent inflation. And just as a reminder for proponents of spending reform, the entire Pentagon budget last year was $805 billion, or 13% of all federal spending, so unless we’re willing to tackle entitlements, any “reform” is simply trimming the edges.
Until the 16th Amendment was ratified in 1913, virtually all federal revenue came from tariffs. A tariff is a subset of a consumption tax. Unlike the income taxes that penalize earnings, consumption taxes penalize spending, which in turn incentivizes savings without punishing earnings. Depending on what is taxed and the tax rate, consumption taxes can be regressive because lower earners spend a greater share of their total earnings than wealthier people, who can afford to save more. However, consumption taxes can be constructed to be progressive, such as through luxury value-added taxes or exempting necessities. A tax structure could also tax vegetables at 0%, ice cream at 5%, cigarettes at 20%, and yachts at 100% — this is obviously a progressive tax structure, like our income tax regime today, but unlike our income tax regime, it would reward earning money and saving it.
Last year, the United States only imported $3.9 trillion worth of goods. By my own calculations, to replace $2.2 trillion in lost personal income tax paid to the federal government, we would need to tax $3.9 trillion of imports at an average rate of 56%. Paul Krugman says that to account for the reduced demand for imports that would result from tariffs, the average tariff rate would actually need to be $133%, but as usual, take anything and everything said by Krugman with a grain of salt.
Both personal income taxes and tariffs incur significant deadweight losses, and there is no question that entitlement spending that acts as a generational wealth transfer from the young to the wealthiest generation in human history is the real source of our current fiscal crisis, not insufficient taxation. Given the amount of revenue Trump’s plan would need to replace, the resulting tariffs could not be limited just to our enemies, and the sheer rate of required tariffs would likely trigger a trade war with our allies.
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While the GOP could likely unite to impose tariffs against China as a diplomatic tool, free market-minded conservatives would be less likely to favor punishing our NATO allies. Furthermore, one study estimates the consumption hit to the average U.S. household at 3.5%, and the real economic losses to the country overall could be much greater with tariffs at that scale.
A smaller-scale replacement of the income tax with a luxury VAT or other consumption tax would absolutely be an improvement on our current system, but limiting the consumption tax to imports would create a diplomatic headache and real economic losses that avoid the real source of the problem: spending.