The Great Depression got started with the passage of the Smoot Hawley Tariff in the United States, by the Republican Party, which immediately set off a cascade of retaliatory tariffs worldwide. This alone did not cause the Great Depression, but it did cause the initial downturn. This was followed by a long string of bad decisions in reaction to that downturn, such as Republican Herbert Hoover’s 1932 tax increase which took the top income tax rate from 25% to 63%.
After World War Two, the whole world came to recognize that the Trade War of 1930 was a major contributor to the Great Depression. At the 1944 meeting in Bretton Woods, New Hampshire, they began a long postwar movement toward Free Trade, with a proposal for an International Trade Organization, to go along with the International Monetary Fund and World Bank also established at the same time. The ITO was not passed, but evolved into the General Agreement on Tariffs and Trade, which then became the World Trade Organization in 1995.
Conservatives thus have some trepidation when they see presidential candidate Donald Trump, representing the Economic Nationalist wing that includes Patrick Buchanan, move again toward tariffs and restrictions on trade. The reasons for this are well known, and include the corrosive effects on the US’s middle class since China entered the WTO in 2001; or arguments that the US, as a continental superpower, needs to retain a large measure of self-sufficiency in key industries including electronics.
Tariffs are taxes; basically, they are a variant of sales taxes. Trump’s proposals, mirroring those of Patrick Buchanan, are for a single-rate across-the-board universal tariff of 10% or perhaps later 20%, instead of the troublesome item-by-item and country-by-country approach of the past. This is actually no different than most countries in the world already have, as a component of their value-added-tax — also of 10%-20% — which also applies to imports.
Nevertheless, more taxes typically have a negative economic effect. This is offset, in the Trump proposals, with lower taxes on business.
The Corporate Income Tax rate would be lowered to 20% from 21%; possibly to 15% for businesses making their products in the US. This is the right idea, but certainly very small. A reduction in the Corporate Income Tax rate to 15% for everyone would be more effective at boosting the economy, and is not that far from the 19% corporate income tax rate now enjoyed by Britain. When you add Corporate taxes in some States, it would mirror Britain’s rate. Forty-four States have their own Corporate taxes; the rate in Alaska, Illinois, Minnesota and New Jersey is nine percent or higher.
Much of the rest of Trump’s tax proposals consist of extending his 2017 Tax Cut and Jobs Act — which led to a noticeably stronger economy, particularly among the lower income brackets. Some tax technicians think that this would lead to some disastrous decline in revenue, compared to if the tax cuts were allowed to expire; but this assumes that these taxes would, in 2027, produce a much higher revenue/GDP figure than the exact same taxes produced before the reform, in 2016. The Congressional Budget Office thinks that revenue from the Individual Income Tax will reach 9.8% of GDP in 2027, with the expiration of the 2017 tax cuts — a whopping 18% higher than the 8.3% actually received in 2016, before the TCJA, and a figure that has never been exceeded except for two years (2000 and 2022), when tax revenues were momentarily boosted by capital gains from huge stock market rises the year earlier. Not gonna happen.
My impression is that the smallish reductions in corporate tax rates would not provide much of an advantage, compared to the potential drag from higher tariffs, especially if they are matched with higher tariffs on US goods from other countries worldwide.
The best and easiest way to produce an economic advantage would be to eliminate all capital gains taxes. To this we could add the elimination of double-taxation of corporate income via dividends, which should be tax-free. An important distortion between debt and equity financing should be ameliorated by making corporate income taxable before interest, known as the “VAT base.” Along with this, interest income should be untaxed at the personal level.
The main argument against eliminating capital gains taxes might be the categorization of some forms of income as capital gains. This is particularly true of investment funds. Income from fund management should be taxed as regular business income, when it is realized. This mirrors the tax treatment of employee stock options today, which are subject to the regular personal income tax (not capital gains) when they are exercised.
Many of the more successful countries in the world do not tax capital gains. These include Hong Kong, Singapore, New Zealand, Belgium, Germany, Malaysia, the Netherlands, South Korea, and Switzerland. It used to include Japan, which did not tax capital gains until 1989.
Trump also introduced the idea of a 60% flat-rate tariff on Chinese imports. Besides potentially providing relief for US workers from international wage competition, this is motivated by geopolitical concerns, with supply lines for key military and other industries compromised by dependence on Chinese and Taiwanese sources. Implementing such a plan would increase the need for more business and growth-friendly tax reductions elsewhere to compensate.
Trump even floated the idea of eliminating the Income Tax altogether, and replacing it with the Tariff as a revenue source. This was actually the regular state of affairs in the United States before the Sixteenth Amendment was passed in 1913. There was no Income Tax.
But, the Federal government was much smaller then. Today, a more realistic idea is to replace the Income Tax with a VAT, which is an indirect tax that resembles both the retail sales tax and various Flat Tax income tax proposals that have been made since the 1980s.
Since the flat-rate tariff is already an inherent part of the VAT found in most countries worldwide, I think Trump is testing the waters for a much more important reform — eliminating the Federal Income Tax altogether, both Individual and Corporate, including a full repeal of the Sixteenth Amendment, and replacing it with a VAT, with a rate of probably around 15%.
For many decades, we’ve avoided the VAT because we don’t want to have an income tax and VAT together, like high-tax European socialist governments. But, adopting a VAT is the best way to replace the income tax.
This resembles the “FairTax” national sales tax proposal popular among conservatives, but would be much better in my view. The VAT is a proven and effective system worldwide, while retail sales tax rates above 10% have been problematic. Replacing the troublesome and destructive Income Tax with a VAT is actually the solution offered by President George W. Bush’s economic advisor Lawrence Lindsey, in his 2013 book The Growth Experiment Revisited.
In the nineteenth century, the United States had high tariffs, domestic excise taxes (sales taxes), and no income tax. It was the most successful country of that century.
(This item originally appeared at Forbes.com on October 8, 2024.)
