Income Taxes for Tariffs: Dollars to Donuts
We did not expect tariffs to escalate so quickly as a topic but now it should reach epic scale with Trump jawboning a tariffs-for-income-tax swap idea in DC.
The latest headlines on Trump tariff policies include a pitch for tariffs to replace income taxes, underscoring a fact (not an opinion) stated by Trump’s smarter advisors back in his one term: that is, tariffs are a tax on consumers. They are also an expense hit to importers.
At the very least, this latest strange Trump policy idea should put tariffs higher on the topical priority list for the debates even if behind the leading areas such as health care, women’s bodily autonomy, immigration, and NATO, among others.
The media has been reporting that the idea of tariffs replacing income taxes (or being used to reduce corporate taxes) was brought up in multiple forums when Trump met with House and Senate leaders as well as CEOs in Washington.
A tariff program of the sort envisioned would be extremely inflationary and slam the consumer sector. If it doesn’t push consumer prices higher (it will), then it must crush corporate expense lines.
The new “tariffs for taxes” idea has an ugly ironic twist: Since tariffs are supposed to deter imports, you are targeting an import base that by definition is supposed to decline by virtue of the program design itself. That means revenue will decline over time or you raise tariff rates again. Then what?
The dollars-to-donuts phrase in the title may be a bit outdated now after a few years of inflation and the proliferation of designer donuts, but trading off very real and high-income tax revenues for tariffs makes for a very challenging math equation. We just thought it worth wrapping a trading week with the latest poorly researched (or not researched at all) and nonspecific proposal on bringing taxes down after the next election.
Winging such items to CEOs and the GOP leadership with no specifics (as always) gives Trump an escape hatch. Trump has already called for across-the-board 10% tariffs without any clarity and 60% tariff levels on China. This is no small issue given the unquestioned obedience he now commands in the Senate and House. In 2017 it was noise. In 2025, it will be edict.
In a meeting with GOP leaders, it is hard to imagine anyone asking the trick question of Trump “Who pays the tariffs?” in a crowded room. Someone may have asked it, but no one might have heard in a room with so many lapdogs barking. We looked at a range of these tariff issues and trade risks earlier this week (see Trade Flows: More Clarity Needed to Handicap Major Trade Risks 6-12-24). This latest scheme is a new one even if the approach of zero analytical support is old hat.
Our running theme on tariffs has been someone should make Trump state that the “buyer pays” and force him to just say it in a debate. It is Biden’s opportunity to show his mettle on critical economic matters and how loud and lost Trump is on some very critical factors. If Biden and his advisors cannot smoke that out, they will be living up to the reputation of incompetence some hurl at them. Even the Wall Street Journal reacted this morning indicating it would take 70% tariffs to replace the income tax base. Forbes weighed in at 85%. Some have said it would take well over 100% tariffs.
There are a few easy (and painfully obvious) questions to ask:
Once again, Mr. President #45, who pays the tariff, the importer (buyer) or the exporter (e.g., China)?
Will this be a blanket tariff program on all imports? Who gets to pick them?
Will there be exclusions for free trade agreements? Or do those deals get summarily scrapped?
Can you please explain where you deposited the tens of billions you collected from China as you told the G7? Or did you in fact collect zero from China?
Did any of your think tank allies forecast a revenue target?
Are you expecting trade retaliation? (Note: Retaliation is a certainty).
Will you seek bailouts for those on the other side of the retaliation (such as the ag sector bailout where the cost materially exceeded the auto bailout)? How will you decide who gets a bailout? (That is a loaded question).
Will the tariff strategy apply to all imports including all the top import trade partners with the EU at #1 (18.8% of LTM imports), Mexico #2 (15.6%), China #3 (13.6%) and Canada #4 (13.4%) that comprise 61% of imports?
Will it exclude free trade partners (notably Mexico and Canada)? Does that include Canadian oil? Does this mean your USMCA deal will get scuttled?
Will these constitute a WTO violation? (Hint: yes). Does that even matter? Would the US withdraw from the WTO if they ruled against such a program? Or just ignore the WTO?
And for one last one…. Will this be another one of the sweeping topical issues where “We will have a plan in a few weeks? (see Trump’s Time Magazine interview). It has been years since you promised a health care plan. When does this one get some transparency?
Border adjusted tax flashback N+1…
This is not the first major tariff-for-tax initiative. The border adjusted tax (“BAT Tax”) was the brainchild of Ryan and Brady back in 2017, so the idea is not new. In prior lives, we looked at the structural weakness of that program and intuitively nonsensical assumptions of currency adjustments that were built into it. Groups such as the Tax Foundation and others usually shred tariff ideas for the taxes they are.
We also gave a quick summary on the BAT Tax in a recent commentary (see Trade Flows 2023: Trade Partners, Imports/Exports, and Deficits in a Troubled World 2-10-24). The plan was so bad that the Senate did not even consider it, and the record income tax reductions were instead rolled in by the end of 2017. We can expect the Senate to fall into line with Trump’s name on it.
The West Coast egghead academic that the House GOP wheeled out to defend the BAT Tax made assumptions on dollar strength that would preclude inflation. The weakness of the BAT Tax plan is not worth shooting holes in at this point, but assuming perfect predictability of all currency moves in perfect symmetrical proportion to import flows is something for a currency analyst trying his hand at stand-up comedy on the trading floor. The idea that some currencies get managed by their governments with an eye on the dollar was not covered in the analysis we saw from their hired-gun-Professor-of-choice (I assume his only compensation was exposure and bragging rights).
How a super strong dollar as predicted was going to help the US export market also did not get much focus that I saw (as in any). Even if the dollar strengthened, the mix of currency reactions could vary widely, and commodities denominated in dollars were not even considered in such sweeping assumptions.
The immediate takeaway on the BAT Tax was around cost spikes for those with offshore supplier chains. The corporate sector reactions ran from alarmed to horrified. You can pick an industry and follow the import trail, but Retail execs at the time got on the business channels and highlighted how such a plan promised bankruptcy and uneconomic businesses. That is especially the case when there are few (or zero) substitutes available for the product or at a cost that does not crush their very narrow margins. The inflation elements of the BAT Tax were more easily explained since “buyer pays.”
Tariffs are one area of facts and very basic concepts that Trump cannot hide from since he just elevated it dramatically once again. We can assume he is getting nervous about debates since this week he was saying “maybe I should lose the debate on purpose” since he does not want Biden replaced on the ticket. The ground rules in the debates cannot be disrupted by sheer noise and interruption, so Biden can corner him on this topic easily (unless he really is lame).
Trump asking for drug tests and “working the refs” can be easily dealt with. The Biden team should get in the game and say “I will take a drug test right after you take a lie detector test. We pick the questions. Man Up, Donny.” More hardball and with the pitch aimed high and inside should be the plan. Trump takes greats pride in his “high IQ.” Let Trump prove it. For Biden, he can disprove Trump’s basic grasp of economics and most certainly tariffs.