Trump, in his Joe Rogan podcast appearance, made clear he likes the 19th century tariffs system, and feels the income tax was a mistake.
He also made clear he favors completely replacing the income tax with tariffs (watch video here). Would that be a better tax system for average American households?
The fact nearly half of Americans don’t pay any income taxes, but would pay for tariffs, provides a clue. Trump’s proposal would fulfill a long-held Republican dream of shifting the portion of government spending funded by high-income taxpayers to wage earners and consumers.
First of all, it’s a myth that foreign countries pay tariffs. This is obvious from the fact that tariffs are collected when goods enter the U.S., not in the country of origin. A foreign manufacturer sells goods to an importer, who pays for the goods, for shipping, and any customs duties.
The importer then passes those costs, along with his markup, to domestic wholesalers or distributors, who keep passing those costs through the retail chain to the final consumer. That consumer is who pays the tariff. Imposing tariffs on imported goods raises the retail price of those goods.
Thus, tariffs are effectively a value-added or sales tax. Rich people love the idea of replacing income taxes with V.A.T. or sales taxes. Why? Because they spend a much lower share of their income on taxed goods and services than persons of ordinary means.
Let’s do an example. Citizen A makes $50,000 a year, spends $45,000, and saves $5,000. At a sales tax rate of 10%, he would pay $4,500 or 9% of his income to the tax collector. Now let’s say Citizen B makes $500,000 a year, spends $150,000 on his lifestyle, and invests the rest. At the same 10% sales tax rate, he would pay $15,000 of taxes, or 3% of his income, in taxes. A CEO making $50 million a year, and spending $5 million, would pay a 1% effective tax rate.
Of course such a tax system is wildly unfair. But conservatives love it so much they floated a brazen proposal misnamed the “Fair Tax” (details here), which would have replaced the income tax with a national sales tax. Although that proposal called for an initial tax rate of 23%, many experts concluded the tax rate would have to exceed 30% to be revenue-neutral, and could approach 40% if payroll, estate, and gift taxes also were eliminated. That means in Seattle, where the sales tax exceeds 10%, taxes would add more than 50% to the price of every purchase.
The “Fair Tax” was a political non-starter, and no recent attempts have been made to revive it. Trump’s tariff scheme isn’t exactly a Fair Tax, V.A.T., or national sales tax in disguise, because it would only tax imported goods. But that also means it would fall far short of generating the income tax revenue it would supposedly replace, creating enormous deficits.
Then, one of two things would happen. Either bigger deficits would cause inflation, which is another kind of tax on earnings and savings, or deficits could be avoided by slashing federal spending — another Holy Grail of conservatives. You would hear, “Look at these deficits, we can’t afford Medicaid, afford food stamps, national parks,” etc. Republicans have always wanted to cut spending on programs they don’t like, which generally are programs that help people less well-off then themselves.
Shifting from income taxes to consumption taxes has other problems. One is drastic and unpredictable volatility in tax revenue stemming from the fact that consumption taxes are paid only if people buy stuff, and personal spending fluctuates much more than income does. Washington State, which relies on sales tax and has no income tax, has always faced boom-or-bust budget cycles, which makes it hard to fund state programs on a steady basis.
Another problem is that high consumption taxes tend to depress consumption. Since 70% of the U.S. economy is consumer-based, a pullback in consumption caused by high taxation of purchased goods and services would inhibit economic growth and cost the economy jobs. Trump’s tariffs would have less impact than a broad-based consumption tax like the “Fair Tax” or a national V.A.T. or sales tax, but it would still have an impact.
But the biggest objective to piling on any more consumption taxes is doing so would widen the gulf between rich and poor. Consumption taxes, whether tariffs or V.A.T. or sales taxes, shift tax burden from rich to poor. There’s no getting around that. And that’s exactly why the rich love them so much.
Finally, there’s no way to make tariffs or any other consumption-based tax progressive. Despite complaints the rich “don’t pay their fair share,” they do pay more federal taxes, which is offset by the regressivity of state and local taxes, so overall we have close to a flat-tax system in America. For reference, about two-thirds of total taxes are federal, and one-third are state and local taxes. To maintain this distribution of tax burden, a progressive federal tax system is essential.
Now, for an 8-minute tutorial on tariffs, watch the Wall Street Journal video below.