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Ron Insana: How Trump's pitch to replace the income tax with tariffs on imports could rattle the economy

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Former President Donald Trump's recent proposal to replace the U.S. income tax with a tariff on all imported goods is a twist on a clarion call from conservatives — and it could come with unintended consequences.

This week, Trump floated the concept of imposing an "all tariff policy," ultimately to eliminate the income tax, sources told CNBC.

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Entities like the Kemp Commission and Steve Forbes have commonly called to replace the income tax with a flat tax.

Historically, that flat tax, as it was proposed in years past, would retain a portion of the mortgage interest deduction and the ability to deduct state and local taxes while also pledging to be revenue-neutral A revenue-neutral flat tax would probably be close to a 22% rate, but that figure was from a debate now decades old.

Trump's proposal brings a new wrinkle to the movement, as it would replace the income tax with a levy on all imported goods.

The complexity of replacing revenue

As of 2023, the U.S. imported about $3.8 trillion in goods and services from abroad.

So, the key question here is how large must the tariffs be to bring in $2.5 trillion in revenue that the government currently garners from income taxes?

Simple math would suggest that the government may need to impose a 65% tax on all imported goods and services to raise the needed $2.5 trillion.

Admittedly, that may not be the proper way to calculate the tariffs, but it may also understate the rate at which tariffs would be levied to capture that revenue, given that a decline in multilateral trade would be a likely outcome if such a proposal came about.

Unintended consequences

There would also likely be tit-for-tat retaliation among America's trading partners, leading to a marked fall-off in global trade and economic activity.

Such an imposition would be a regressive tax that would likely hit middle- and lower-income families the hardest. That's because they purchase a bulk of lower-cost products that are sold by brand-name companies that source their goods from other countries.

We've had experiences with large-scale tariff impositions amid the Great Depression. Indeed, in 1930, President Herbert Hoover signed the Smoot-Hawley Tariff Act, hiking the average tariff by about 20%. The result was a deepening of the economy's decline, a shift in capital flows and an increase in joblessness both at home and abroad.

Tariffs can prevent or correct abuses among countries that dump goods into foreign markets and hurt domestic manufacturers. For instance, today we see China looking to flood the global market with electric vehicles, solar panels and other goods that they have overproduced.

Fringe proposals

Both the Trump and Biden administrations have turned to tariffs to punish China, in particular, for violating the World Trade Organization rules that govern global trade.

Having said that, scrapping the income tax and replacing it with massive tariffs is both inflationary and recessionary as it would raise prices, dampen consumption and strip the U.S. of its ability to source goods and services from friendly partners, as well as adversarial nations.

At a time when inflation rates are falling and energy prices are stable, abolishing the national income tax for global tariffs may be extremely damaging to growth both here and abroad.

Meanwhile, Democrats, including President Joe Biden, are calling for substantial tax hikes to address the gaping holes in the nation's budget.

Calling to raise the top marginal rate on capital gains to 44.6%, as well as proposing a levy on unrealized appreciation, would be damaging to capital formation and domestic investment.

These are all fringe proposals that do not seriously address the need for a more balanced budget process and more rational spending and taxing decisions.

I worry less about Biden's proposals, largely because they would never pass in Congress.

However, imposing tariffs is another matter entirely. Under certain circumstances, these levies can be imposed by executive order.

Scrapping the income tax would take an act of Congress, given the legislature's constitutionally mandated "power of the purse."

Trump's proposal should be a "be careful what you wish for" moment.

Such a move would adversely affect the U.S. economy, raising taxes on those who can least afford them, stoking inflationary fires and, at least theoretically, spurring a recession.

 — CNBC contributor Ron Insana is CEO of iFi.AI, an artificial intelligence fintech firm.

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