Former President Donald Trump recently suggested that he is considering instituting a policy of tariffs that would lead to the elimination of the federal income tax. While the idea of eliminating income taxes sounds appealing to a lot of people, it is important to understand what it would mean for the economy and individual wallets.
How Tariffs Work
A tariff is a tax levied on imported goods. It is typically used to increase the cost of foreign-made products, particularly those that come from countries with significantly lower labor and materials costs or those that allow unfair trade practices. The primary goal of a tariff is to level the playing field for domestic companies that keep jobs local and are subject to the labor laws of the United States. Tariffs are paid to the U.S. government before foreign goods can be brought into the country.
The idea behind a tariff is that the additional cost incurred by the foreign manufacturer will be passed on to the consumer in the form of a higher retail price. During Trump’s presidential term, he used tariffs to increase the cost of goods made in China, so American goods could be priced more competitively. This strategy was aimed at boosting domestic manufacturing and reducing dependency on foreign imports.
The Impact of an All-Tariff Plan
If all imported products coming into the United States had increased tariffs, there would be both short-term and long-term impacts. In the short term, prices would rise on all imported goods. Consumers could opt to either pay the higher price for the imported product or choose a domestic product, which would also typically have a higher price than the pre-tariff imported product. No matter which choice the consumer makes, the price they would pay would be higher than the previous price of the imported product. So overall prices will rise.
The longer-term effect would be a reduction in the quantity of foreign goods imported into the United States. The law of supply and demand tells us that when prices go up, demand goes down. This, after all, is the goal of the tariff — to reduce imports. There will be fewer imported goods available in the United States, which could also drive up prices overall as domestic producers may not be able to meet the increased demand immediately or as efficiently as foreign producers.
The Impact of Substituting Tariffs for Income Taxes
The concept of replacing income taxes with revenue from tariffs also has short- and long-term impacts. In the short term, the ‘all-tariff’ plan would act as a consumption tax — essentially a sales tax on steroids. Because the cost of a tariff is passed on to the consumer, and consumer prices will go up, consumers are paying more for everything they buy.
This type of consumption tax affects lower-income consumers on a disproportionate basis. People who spend a higher percentage of their income on necessities — housing, utilities, food, clothing, etc. — would pay a higher amount in tariffs, relatively speaking. Those who spend less on necessities or who earn income from investments would pay less. This creates a regressive tax system where the burden falls more heavily on those with lower incomes.
On a longer-term basis, the intended effect of a tariff is to reduce the amount of imported goods. So, the all-tariff plan might eliminate the need for income taxes in the short term, but if it works as intended, it should bring in less money over time. The current income tax system in the U.S. is designed to bring in more money over time as incomes rise and as the economy grows. Tariffs, however, would likely lead to decreased import volumes, and thus, decreased tariff revenues over time.
Keeping Up With the Joneses Under an All-Tariff System
Tax-weary consumers might think that replacing income tax with tariffs would be a good thing for them. The truth is, it will benefit the wealthy far more than the lower and middle classes. Here’s an example to illustrate this point:
Two families, the Smiths and the Joneses, each have the same monthly necessary expenses, excluding their mortgages, of $6,250, or $75,000 a year. The Smiths have an annual income of $150,000, which barely covers their expenses. The Joneses, on the other hand, have an annual income of $300,000, which allows them to easily cover expenses and put some money into savings. So, the Smiths are paying a higher percentage of their income on necessities.
Under a tariff-only plan, each family would pay the same amount in tariffs because they have equal monthly expenses excluding housing, so the increase they would see from tariffs would be the same. Yet the Joneses have double the annual income of the Smiths.
Under the current progressive income tax system in the United States, a family earning $300,000 per year would pay more in taxes than a family making $150,000 a year. Replacing the income tax system with a tariffs-only system turns this on its head and shifts the burden from higher-earning households to those that earn less. This shift would make the tax system less equitable and could exacerbate income inequality.
Economic Implications of an All-Tariff System
The idea of eliminating federal income taxes in favor of tariffs has far-reaching economic implications. For one, it could lead to increased prices for a wide range of products, from electronics to clothing, as most consumer goods are imported. This would result in higher overall living costs, putting additional financial pressure on households, particularly those with lower incomes.
Moreover, the reliance on tariffs could disrupt international trade relationships. Countries affected by U.S. tariffs might retaliate with their own tariffs on American goods, leading to a potential trade war. This could harm American exporters and lead to job losses in industries that rely on international markets.
The revenue generated from tariffs might also be unstable. Unlike income taxes, which are relatively predictable and stable, tariff revenues can fluctuate based on changes in trade volumes and economic conditions. This instability could make it challenging for the government to budget and fund essential services.
Conclusion
While the idea of eliminating income taxes might sound appealing, replacing them with tariffs would have significant and far-reaching economic consequences. It would likely lead to higher prices for consumers, disproportionately affect lower-income households, and could disrupt international trade relationships. Moreover, the revenue from tariffs might not be sufficient or stable enough to replace the income generated by federal income taxes. Thus, while the proposal might benefit the wealthy, it could create greater financial strain and inequality for the majority of Americans.