THE ECONOMIST: Trump faces a trillion-dollar tariff disappointment

In the early 20th century, before America introduced an income tax, tariffs paid many of the government’s bills. President Donald Trump wants to revive that approach.

He has repeatedly floated the idea of an “External Revenue Service”, under which Uncle Sam would scrap income taxes and instead rely on levies at the border, with foreigners, at least in theory, funding the American government. “It will be a BONANZA,” Mr Trump posted recently on his social-media site, claiming that tariffs could all but eliminate income taxes for people earning less than $US200,000 ($312,000) a year.

There is plenty to dislike about tariffs. Economists bemoan the distortions they impose on commerce. They are often paid not by “external” firms but by domestic consumers.

In 2020 Mary Amiti of the Federal Reserve Bank of New York and colleagues found that nearly all of Mr Trump’s first-term levies were ultimately borne by American companies, in the form of lower margins, and buyers, in the form of higher prices. Moreover, agreements with Britain and China have reduced overall tariff levels from recent highs, which will cut the revenue they raise. Levels will continue to fall as America inks more deals.

Yet Mr Trump’s tariffs will still bring in large sums. Quite how large? Last year just $US100bn of the total $US4.9trn that the Federal Government collected came from customs duties. Already, though, that figure is rising. Daily data from the Treasury show a spike. By May 13, gross tariff collections had reached $US47b since the start of the year, about $US15b more than last year.

Disentangling how much of this is a result of Mr Trump’s latest levies and how much represents firms rushing to bring in goods ahead of further hikes is tricky; much is likely to be the latter.

A number of economists have nevertheless attempted to forecast tariff revenues. Peter Navarro, Mr Trump’s trade guru, claims that border levies could generate more than $US6trn over the next decade, or $US600b a year. His arithmetic is brazenly simple: take last year’s $US3.3trn in merchandise imports and apply a 20 per cent effective tariff.

Such an approach ignores basic economic dynamics. Higher tariffs reduce demand for foreign goods, shrinking the tax base. They also depress income and payroll-tax receipts, offsetting as much as 25 per cent of the gains, according to most estimates. Factor in retaliation and levy-dodging, and anticipated revenue falls further. Mr Navarro’s trillion-dollar projections rest on a fantasy of stasis, in which buyers, sellers and trading partners shrug off price signals.

Independent estimates of tariff revenues are much lower. The Penn Wharton Budget Model estimates that the full suite of proposed tariffs, including the “reciprocal” levies currently on pause, would raise around $US290b a year over the next decade. Its calculations account for weaker import demand, as well as the effects on corporate-income- and payroll-tax receipts.

Other forecasts are lower still. The Budget Lab at Yale, a non-partisan research centre, forecasts annual revenue of $US180b; the Tax Foundation, a think-tank, puts the number closer to $US140b.

There is an oddity to such calculations, however. The cut in the levy on Chinese goods — from 145 per cent to 30 per cent — does not do much to alter their results. At 145 per cent the tariff was on the wrong side of the peak of the “Laffer curve”, the point at which higher rates reduce, rather than lift, revenue.

It would have prompted imports from China to plummet, meaning tax revenues would have fallen despite the sky-high levy on goods still coming into the country. According to Penn Wharton, a levy of 145 per cent on Chinese imports would raise only $US25b more a year than the current rate of 30 per cent will.

Even with this small mercy, the President’s tariffs will not enable the large tax cuts he so desires. Last year America’s personal-income tax brought in $US2.4trn — an amount forecast to grow to $US4.4trn over the next decade. The Tax Foundation estimates that eliminating income taxes for people earning less than $US200,000 would cost $US737b in 2025, or two to three times what tariffs could conceivably raise.

In theory, a revenue-neutral swap could cover those earning around $US80,000 or less, who account for just 10 per cent of income-tax receipts. But eliminating taxes for low earners would, in practice, mean cutting the lowest marginal rate, which applies to all taxpayers on their initial income, and so would mostly benefit high earners.

A tax bill proposed by Republicans in the House of Representatives is stuffed with other giveaways, including raising most tax-bracket thresholds, which by itself would dwarf tariff income.

Tariffs were able to sustain the federal government in the early 20th century because its spending came to just 2 per cent or so of GDP, being largely confined to debt service, defence and infrastructure. Today that figure is ten times higher.

Imports are a narrow and volatile tax base, making them ill-suited to funding a modern state. The irony is that tariffs would make American spending reliant on Chinese production. Most politicians do not try to return to the early 1900s for a reason.