After CNBC reported that presumptive Republican presidential candidate Donald Trump is considering replacing income taxes in the U.S. with additional import tariffs to offset the revenue shortfall, Nobel laureate and economist Paul Krugman shared his views on the matter through a series of posts on X, formerly known as Twitter, on Thursday.
Impractical Approach: If Trump’s proposal were to be implemented, the average tariff required to supplant the income tax would be 133%, said Krugman. The economist also shared the math behind the estimate. Imports make up about 14% of the U.S. GDP, while the federal income tax revenue, not including payroll taxes, makes up 8%, he said. In order to replace the income tax, tariff rates should be 8/14 or around 57%, he added.
Since tariffs tend to raise import prices to consumers, higher tariffs would reduce imports, the economist said, adding this would mean “you need a higher tariff rate.” This would have a cyclical effect of reducing imports further, necessitating a still higher tariff for generating the income to do away with income taxes, he said.
Determining how high tariffs need to go in the end depends on the elasticity of demand for higher import prices, Krugman said. Assuming an elasticity of 1, the required tariff would be 133%, he explained. “With a higher elasticity, it would go higher, maybe to infinity,” he warned.
The economist also contrasted the situation prevailing now and back then in the 19th century, when the federal government largely paid its way with tariffs. “Because back then the government was much, much smaller,” he said.
“Believing that we can go back to those days is just ignorant.”
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Why It’s Important: Trump reportedly told lawmakers from his party at a meeting at the Capitol Hill Club in Washington D.C. that tariffs could be used to “leverage negotiating power over bad actors.”
Commenting on the idea floated by the former president, New York University Law Professor David Kamin said, “Broadly substituting tariffs for income tax is a sure way to hit hard low and middle-income Americans and reward top.”
Earlier this month, former Treasury Secretary Larry Summers said, in an interview with the Atlantic, Trump’s economic policies, including “compromising the independence of the Federal Reserve Board, enlarging the federal budget deficit by extending his 2017 tax cuts, raising tariffs” etc., are inflationary. He also flagged the real possibility of mortgage rates shooting above 10% under Trump.
One of the pushbacks that President Joe Biden is facing in his potential rematch with Trump is voter perception regarding his ability to shepherd the economy, especially inflation. If Trump gravitates to policies and measures that are inflationary, it could hurt his re-election chances, which are already weighed down by his multiple legal travails.
The iShares TIPS Bond ETF (NYSE:TIP), an ETF tracking the investment results of an index composed of inflation-protected U.S. Treasury bonds, rose 0.39% to $106.77 on Thursday, according to Benzinga Pro data.
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