Ron Insana: Trump's Proposal to Replace Income Tax with Import Tariffs Could Cause Economic Uncertainty

The suggestion by former President Donald Trump to replace the U.S. income tax with a tariff on imported goods is a conservative call, but it may have unforeseen effects.

Sources informed CNBC that Trump proposed an "all tariff policy" this week with the aim of abolishing the income tax.

Conservatives have frequently advocated for replacing the income tax with a flat tax, as suggested by the Kemp Commission and Steve Forbes.

In the past, the proposed flat tax included provisions to retain a portion of the mortgage interest deduction and the ability to deduct state and local taxes, while maintaining revenue neutrality.

A 22% rate was previously proposed as a revenue-neutral flat tax, but this discussion is now outdated.

Trump's plan introduces a new twist to the movement by suggesting to replace the income tax with a tax on imported goods.

The complexity of replacing revenue

In 2023, the U.S. imported approximately $3.8 trillion in goods and services from other countries.

What are the tariffs required to generate $2.5 trillion in revenue for the government, which is currently obtained through income taxes?

To raise $2.5 trillion, the government might need to impose a 65% tax on imported goods and services.

If the calculation of tariffs is not done correctly, it may result in an understatement of the rate at which tariffs will be imposed, which could lead to a decline in multilateral trade if such a proposal is implemented.

Unintended consequences

If America's trading partners retaliate, global trade and economic activity will decline significantly.

A regressive tax would likely disproportionately affect middle- and lower-income families, as they tend to buy more affordable products from brand-name companies that source their goods overseas.

During the Great Depression, we encountered instances of significant tariff increases, such as the Smoot-Hawley Tariff Act of 1930, which raised the average tariff by approximately 20%.

The decline of the economy led to a deepening of the economic downturn, a change in capital movements, and an increase in unemployment both domestically and abroad.

Tariffs can be an effective tool in preventing or correcting abuses among countries that dump goods into foreign markets and harm domestic manufacturers. For example, China is currently 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 employed tariffs as a means of retaliation against China for infringing on the rules of the World Trade Organization that regulate international commerce.

Replacing income tax with massive tariffs would be inflationary and recessionary, as it would increase prices, decrease consumption, and limit the U.S.'s ability to obtain goods and services from friendly and adversarial nations.

Eliminating the national income tax for global tariffs could harm growth worldwide when inflation rates are declining and energy costs are stable.

President Biden and Democrats are advocating for significant tax increases to address the country's budget deficit.

Proposing to increase the top marginal rate on capital gains to 44.6% and impose a tax on unrealized appreciation would harm capital formation and domestic investment.

The proposals being put forth are not substantial in addressing the requirement for a more balanced budget process and rational decisions regarding spending and taxes.

I am less concerned with Biden's proposals since they have little chance of being approved by Congress.

Imposing tariffs is a different issue altogether. In specific situations, these taxes can be enacted through executive decree.

The power of the purse granted to Congress by the Constitution would require an act to scrap income tax.

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

The proposed move could negatively impact the U.S. economy by increasing taxes on low-income individuals, fueling inflation, and potentially triggering a recession.

Ron Insana, a CNBC contributor, is the CEO of iFi.AI, an AI-driven fintech company.