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U.S. Republicans are promising to keep the income tax cuts the first Trump administration introduced in 2017, which are due to be phased out starting next year. Extending them indefinitely will put a big hole back in the already gargantuan U.S. deficit.

On the other hand, Republicans also plan major tariff increases: 10 per cent on all imports and 60 per cent on Chinese imports.  As Martin Sullivan explains in this week’s Tax Notes International (available only by subscription), the revenue gain from the tariff increase will be US$3.97 trillion over 10 years, slightly above the US$3.91-trillion loss in income taxes from extending the 2017 cuts. If Sullivan’s numbers are right, the deficit will remain the same.

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This sheds a different light on the role of tariff policy, as I argued here in June. Instead of just protecting industries from import competition, tariffs could substitute for other taxes in funding public services. In 2023, a 10 per cent tariff would raise US$310 billion for the U.S. government, representing 7.6 per cent of federal revenues and fully a fifth of the deficit.

Even so, the use of tariffs as a revenue-raiser to cut income taxes would have huge implications for global trade policy, inviting retaliation by other countries. The economic losses from shrinking world trade won’t be good for any country, potentially offsetting any economic gains from cutting income taxes.

If the Republicans do win the White House this fall, exactly what happens next is an open question. The Trade Expansion Act (1962) enables the president to apply tariffs on imports that threaten national security, a provision both Trump and Biden used in imposing aluminum and steel imports. Under section 301 of the U.S. Trade Act (1974), the president also has authority to levy tariffs on countries engaged in unfair trading practices — a provision used by both Trump and Biden to impose tariffs on Chinese goods. In May, Biden used Section 301 to propose new tariffs on steel, aluminum, semiconductors, EV batteries and solar cells. But the question remains: will a permanent across-the-board tariff qualify under either legislation?

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In the 19th century, there were long arguments in the British Empire about whether tariffs were “revenue tariffs” or “protective tariffs” (as if they couldn’t be both). Before income taxes, tariffs were governments’ most important revenue source. In Canada’s first half century, custom duties financed over half the federal budget. That began to dwindle with the growth of income and sales tax revenues after 1917. Even so, as late as 1930 tariffs brought in 40 per cent of federal revenue.

But the American Smoot-Hawley tariff of that year and the worldwide “beggar-thy-neighbour” trade war it sparked turned most of the world against trade protection. After World War II, 23 countries adopted the General Agreement on Tariffs and Trade (GATT) to promote trade by removing tariffs that then averaged 23 per cent. By the time 123 countries formed the World Trade Organization in 1995 the average trade-weighted tariff was just five per cent. With freer trade the norm, tariffs lost their appeal as revenue-raisers.

They’re still critical for the public finances of many developing countries, however, as they’re easier to collect than income and sales taxes, especially in cash-based economies with large informal sectors. Among the countries most reliant on tariffs and export taxes are Botswana (where they are 27.5 per cent of revenues), Namibia (26.3 per cent), Niger (25.6 per cent), Nepal (18.8 per cent), Ecuador (16.4 per cent), Pakistan (16.0 per cent) and Argentina (13.1 per cent). In contrast, trade taxes are much less important in Germany, (0.6 per cent of revenues), Canada (0.8 per cent), China (1.5 per cent), the United States (1.9 per cent) and Australia (3.1 per cent).

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Using tariffs as a major revenue-raiser in an important developed economy — maybe the most important developed economy — would be a profound change in global public policy. Tariffs do have some advantages — though more political than economic. They clearly appeal to voters who believe cheap imports have destroyed domestic jobs. In large economies like the U.S., China and the EU, their inflationary effect on consumer prices may be partly offset by a reduction in producer prices as other country’s producers lower their prices to get into these three countries’ gigantic markets. In this way the big countries effectively export part of the tax. Finally, if the tariffs are used to reduce unpopular income taxes, that’s a plus, too. Nonetheless, high tariffs pursued by all countries will shrink trade while simultaneously raising consumer prices and lowering demand for workers in many industries.

Since we’re not one of the favoured three mega-economies, we really don’t want to go there. We’re the fourth largest exporter of goods to the U.S. after the European Union, China, and Mexico. An across-the-board U.S. tariff would hit us hard. Our two largest exports, energy and vehicles, would become less competitive in U.S. markets and the loonie would depreciate, providing more incentive for our best and brightest to move.

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Imposing a 10 per cent tariff on our imports could raise C$60 billion, assuming imports don’t shrink, though they will. Don’t think Canada is not game to try it. The Liberals have invited comments on “carbon border adjustments” that are essentially tariffs. For that matter, the digital service tax is just a tariff on foreign suppliers, which is why it so annoys the United States.

Even if income taxes are very inefficient, tariffs are a poor replacement. There is a much better way of cutting income taxes: value-added taxes, like our GST. Unfortunately, Congress has rejected such taxes for years. Paul Ryan, speaker of the House during Trump’s first two years, pushed for a VAT-like corporate tax with 100 per cent write-offs for capital expenditures, plus border adjustments: an exemption for exports and no deduction for import costs. Equivalent to export subsidies and import tariffs, it was strongly opposed by importing industries and the whole idea was scrapped.

If tariffs do become a popular source of revenue, pity the global consumer. And pity workers who lose their jobs as tariffs shrink world trade.

Financial Post

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