Donald Trump has decided to once again cut taxes for Americans. This time, he is aiming for a much more radical reform than the one he championed last time he was in the White House.
The New York Post has the story:
Former President Donald Trump on Thursday raised the idea of abolishing income taxes and replacing the primary government revenue source with tariffs, according to a Republican lawmaker. The proposal was brought up by the 77-year-old presumptive GOP nominee for president during a joke-filled “pep talk” with congressional Republicans on Capitol Hill, his first since leaving office in January 2021.
This idea is no joke
Before we get into the meat of his idea, a rhetorical point is in order. The “joke-filled ‘pep talk’” comment is misleading. It does not refer to the content of the conversation, i.e., the idea of abolishing the income tax. Trump is not a man who says anything out of the joy of the situation, especially not when it comes to politics. The “joke” remark is instead a reference to the light-hearted atmosphere in the meeting.
We can safely assume that what we have here is a radical and, at least in concept, serious tax reform proposal from a former and presumptive next president. It is also worth remembering that it comes from a man who has already gotten Congress on board with a major tax reform. The last one, to be clear, was no small achievement: it radically cut the corporate income tax from 36% to 21%, and it limited the SALT (State and Local Tax) deduction.
Both these reforms were ideologically controversial and required significant political skills from President Trump. Yet he got them both done, which suggests that, as president, he could very well decide to get this even more radical idea through Congress.
It is not just Trump’s presidential track record that suggests he could do this. One of Trump’s close allies, economist Steve Moore, had a similar idea a few years back. I have no idea if Moore is currently affiliated with Trump’s campaign, but I would not be surprised if Trump listens to him.
He would be right in doing so. Moore is a good economist with decades of Washington insider experience. He has a keen understanding of the intersection of economic policy and politics. Back in 2020, he proposed the suspension of the federal payroll tax as a way to reignite the economy.
At the time, I criticized Moore, in part concerning the timing. It would have caused a large initial increase in the budget deficit right when the Federal Reserve was busy buying every Treasury security it could get its hands on. Given the close connection between deficit monetization and inflation, I am glad nothing came of the idea back then.
How would the reform be implemented?
Taking all this into consideration, it is always interesting to discuss radical tax reform ideas, especially if the macroeconomic and fiscal context is different from what it was in 2020. Furthermore, the proposal that Steve Moore made in 2020 shows that the notion of suspending or abolishing the income tax is not a new bird in conservative Republican circles. It is worth a closer look.
Again, let us keep in mind that this is nowhere near a formal policy proposal from Trump’s campaign. While not underestimating the former president’s ability to float radical political ideas as ‘test balloons’, we should also not overestimate what we know so far.
With that in mind, I have three questions. The first one is about how the reform would be implemented. Assuming that the idea is straightforward enough—abolish the federal income tax and replace it with tariffs or comparable revenue sources—its practical consequence would be to reverse the expansion of the federal government’s taxation powers that came with the 16th Amendment to the United States Constitution:
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
Trump can never hope to achieve a de jure repeal of this amendment; it would require the passage of a new constitutional amendment stating that the 16th Amendment has been repealed. Given the complex process required to amend the Constitution, this is an absolute non-starter.
More realistically, Trump would seek a de facto suspension of the amendment by statutory reform; the federal tax code would be changed so that the tax rates currently in effect are all set to zero. This could likely be accomplished with the same ease as Trump’s 2017 tax reform.
Can tariffs replace the lost revenue?
Given an adequate Republican congressional majority, my next question concerns the fiscal effect of the repeal of the income tax. In the article on Trump’s idea, the New York Post quotes Erica York, a senior economist with the Washington-based Tax Foundation. York makes a succinct comment:
The individual income tax raised about $2 trillion annually on a tax base of personal income roughly $15 trillion … Customs duties currently raise about $80 billion annually on imports of $3.4 trillion … [G]ood luck milking $2 trillion of tax revenue out of $3 trillion of imports
While York’s numbers are not entirely correct, she captures the big-picture problem. If a future Trump administration were to try to replace the income tax with tariffs, the shift in the tax base would be like trying to pull a freight train’s payload with a Fiat.
Here are the numbers that York refers to: According to the White House’s Office of Management and Budget, in 2023, the personal federal income tax brought in close to $2.2 trillion in revenue. However, this is not the only tax that the federal government levies on personal income: there is also the Social Security tax, which last year contributed just over $1.6 trillion in revenue.
It is a common mistake to assume that the Social Security taxes are not income taxes. The reason for this mistake is that these taxes are dedicated to specific spending purposes, namely to fund old age pensions, disability compensation, and related benefits. However, economically, a tax is defined by its function, not its purpose; the Social Security tax is levied on personal income and therefore has all the same economic effects, proportionate to its size, that the ‘normal’ income tax has.
Would Trump include Social Security taxes in his proposal? A formal repeal of the 16th Amendment would make the Social Security tax unconstitutional, but since there is practically no chance of such a repeal, the fate of the Social Security tax will be determined primarily by political considerations.
Assuming that Trump’s proposal would repeal both taxes, the loss of revenue—based on 2023 numbers—would amount to $3.8 trillion, or 85.4% of all federal tax revenue.
On the revenue replacement side, Erica York is generally correct, but off by $400 billion. The total value of imports of goods and services to the United States in 2023 was $3.8 trillion. Replacing just the personal federal income tax would require a 58% tariff on all imports; adding the Social Security tax raises the tariff to 100%.
York is of course completely right when she wishes Trump good luck with “milking” imports on that amount of revenue. However, if we take the term ‘tariff’ back to its original meaning, it applies to trade, which includes both imports and exports. If we extend the income-tax-replacing tariff accordingly, we get a tax base of $6.8 trillion. The tax rates now fall to 32.3% and 55.9%, respectively.
These tax rates are still far and away too high to be realistic, and we haven’t even mentioned the dynamic economic effects of this tax reform. Furthermore, it seems politically bizarre that a president with a strong ‘America First’ agenda would place tariffs on American exports. Therefore, any proposal of an income-tax repeal would have to rely on a completely different revenue replacement package—or be coupled with epic spending cuts.
What about the EITC?
My third question about this reform relates to the Earned Income Tax Credit. This is a so-called refundable benefit that is paid out to eligible low-income households. The refundability part means that it is a cash benefit: those who can claim the EITC on their tax returns get a check from the federal government. The amount varies with family size and is inversely related to their income; the less a family earns, the more they get.
Logic dictates that if we do away with the personal federal income tax, we cannot have a cash benefit that is directly tied to what income taxes people pay. However, abolishing the EITC is also economically sound: as I explain in my book The Rise of Big Government, the combination of benefits that fall with rising income, and income taxes that rise with rising income, creates a high marginal tax effect for EITC-eligible taxpayers. At the time I wrote the book in 2017, that marginal tax effect was equal to what the same family would encounter if they earned over $400,000 per year.
Simply put, the EITC discourages workers from pursuing higher incomes and better jobs. At the same time, the benefits are significant, especially for those who get more money in their EITC check than they pay in federal income taxes.
In short, as economically undesirable as the EITC is, ending the program would come with a big political price for anyone in Congress who votes accordingly. That price grows even bigger if we consider the contrast against those who would benefit the most from the income-tax repeal. According to IRS tax data from 2021, the 11% of taxpayers who earn $200,000 or more pay 71% of all personal federal income taxes.
This means that a straightforward reform where the personal federal income tax and the EITC disappear would leave some of the lowest-earning households worse off, while high earners benefit substantially.
I do not believe for a moment that Donald Trump would propose this reform if he had not thought about the effects it would have on low-income earners. If I were to make a guess, his reform plan—if it materializes—will include a proposal for some sort of ‘citizen’s income’ to replace the EITC. What we have just seen was a political test balloon to see what people think, and if anyone has a better idea than he does.
