Candice Horbacz
Tariff revenue, which significantly more than tripled as a share of GDP under the tariff increases imposed by President Donald Trump since 2018, has proven to be an unstable fiscal instrument. This instability was starkly highlighted in February 2026, when many of these new tariffs, enacted under untested legal authorities, were subsequently struck down by the Supreme Court. As the current administration works to craft replacement measures, a compelling argument is emerging for policymakers to devise an independent and robust alternative fiscal plan. Such a plan is deemed critical to simultaneously address the twin challenges of pervasive economic uncertainty and escalating fiscal instability that continue to loom over the American economy. The recent judicial intervention underscores the precarious nature of relying on tariffs as a long-term, stable source of government income, forcing a reevaluation of the nation’s broader tax strategy.
The origin of the current tariff landscape can be traced back to 2018, when the Trump administration initiated a series of broad tariff increases. These measures were primarily justified under various legal provisions, including Section 232 of the Trade Expansion Act of 1962, citing national security concerns for steel and aluminum imports, and Section 301 of the Trade Act of 1974, targeting unfair trade practices, particularly those related to intellectual property theft from China. Additional tariffs were levied under Section 122. The stated intent was to protect domestic industries, compel fairer trade practices from international partners, and reduce trade deficits, particularly with China. These tariffs, essentially taxes imposed by the United States on goods imported from other countries, were designed to make foreign goods more expensive, thereby theoretically encouraging consumers and businesses to purchase domestically produced alternatives. Initially, these tariffs did contribute to a noticeable surge in federal revenue. For instance, data from the Congressional Budget Office (CBO) indicated a significant increase in customs duties collected, moving from approximately $40 billion in 2017 to over $80 billion in subsequent years, effectively tripling their share of GDP. However, this revenue stream was fraught with economic consequences, including higher costs for U.S. businesses and consumers, supply chain disruptions, and retaliatory tariffs from affected trading partners, most notably China and the European Union. These retaliatory measures further complicated global trade dynamics and added to economic uncertainty.
The legal foundation of these tariffs, particularly those enacted under executive authority without explicit congressional approval for specific trade actions, faced considerable scrutiny. Businesses and trade organizations mounted challenges, arguing that the administration had overstepped its constitutional bounds or misapplied existing statutes. These legal battles culminated in the Supreme Court’s landmark decision in February 2026, which invalidated a significant portion of the tariffs. While the specific legal reasoning is complex, it generally centered on the interpretation of executive power in trade policy and the limits of delegated authority from Congress. The ruling created an immediate fiscal void, as the revenue projections had incorporated these tariff collections. This legal setback not only removed a substantial, albeit volatile, source of federal income but also injected a new layer of uncertainty into trade relations and domestic economic planning. The administration is now tasked with formulating new approaches, either by attempting to re-impose tariffs under different legal frameworks or by seeking legislative solutions from Congress, which could prove challenging given the contentious nature of trade policy.
Even with the temporary boost in tariff revenue, America’s long-term fiscal trajectory remains a cause for serious concern. The national debt has continued its relentless climb, propelled by persistent annual budget deficits. Current projections from the CBO paint a stark picture: annual budget deficits are anticipated to exceed $2 trillion within the next few years, and alarmingly, they are projected to surpass $3 trillion by the end of the budget window in 2036. This trajectory is unsustainable and poses significant risks to the nation’s economic health. A particularly alarming component of this fiscal outlook is the escalating cost of servicing the national debt. Interest payments on the debt are forecasted to exceed a staggering $2 trillion by 2035. To put this into perspective, these interest payments would cost more than the entire defense budget and almost as much as major entitlement programs like Medicare. This enormous allocation of funds to debt servicing represents a significant opportunity cost, diverting resources that could otherwise be invested in infrastructure, education, research, or other critical public services. The increasing burden of interest payments also makes the federal budget highly vulnerable to fluctuations in interest rates, which could exacerbate the problem further. The aging population and rising healthcare costs associated with programs like Medicare and Social Security are fundamental drivers of these long-term fiscal imbalances, requiring comprehensive solutions beyond temporary revenue measures.
In response to these pressing fiscal challenges and the instability of tariff revenue, the Tax Foundation, a prominent non-partisan tax policy research organization, has put forth a comprehensive analysis in its new book, "Options for Reforming America’s Tax Code 3.0: A Policymaker’s Guide to Tax Reform Trade-Offs." This publication critically examines various avenues for tax reform, including a specific proposal to remove all the new tariffs imposed since 2018 and revert U.S. tariff policy to its 2017 baseline. The rationale behind removing these tariffs is rooted in economic efficiency: tariffs are widely recognized by economists as trade barriers that impose an economic burden by raising prices for consumers and businesses, reducing the availability of goods and services, and distorting investment decisions. While eliminating these tariffs would undoubtedly ease the economic burden and reduce distortions, it would also significantly add to the already high federal deficits by forfeiting a substantial revenue stream.
Since the initial publication of the book, additional tariffs have been implemented, further complicating the fiscal landscape. Accounting for these new levies, the Tax Foundation now estimates that a complete removal of all tariffs imposed since Trump’s first term would result in nearly $1.8 trillion in forgone revenue for the federal government over the decade from 2027 through 2036. This substantial revenue loss necessitates a credible replacement strategy to prevent further exacerbating the national debt. Proponents of tariff repeal argue that while the revenue loss is significant, the economic benefits derived from removing these trade barriers would be substantial. Specifically, they contend that repealing tariffs would reduce marginal tax rates on work and investment within the U.S. economy. This reduction in effective taxation on productive activities would incentivize greater economic output, increase hours worked, and stimulate capital investment, leading to broader economic growth.
To offset the estimated $1.8 trillion in lost revenue from tariff repeal and to provide a more stable, less distortive revenue source, lawmakers are strongly encouraged to consider the implementation of a value-added tax (VAT). A VAT is a form of consumption tax, distinct from tariffs, that is collected incrementally at each stage of the production and distribution of a good or service. Unlike a retail sales tax, which is typically collected only at the final point of sale to the consumer, a VAT is administered throughout the supply chain. Businesses charge VAT on their sales (output tax) but are able to reclaim VAT paid on their purchases (input tax). This credit-invoice system ensures that the tax burden on intermediate transactions is effectively removed, and the cumulative tax ultimately falls only on the final consumer. This design makes a VAT fundamentally neutral between consumption and saving.
A key advantage of a VAT, particularly when compared to the existing income tax system, is its neutrality towards capital investment. The current income tax, by taxing the returns to capital, can discourage savings and investment. A VAT, once fully transitioned, imposes no burden on the normal return to investment – that is, the return required to simply break even. This is in contrast to taxes that might capture "supernormal returns" arising from market power, risk, or innovation. By not taxing the normal return to investment, a VAT encourages capital formation and more efficient allocation of capital across different sectors and types of investment. Furthermore, VATs are generally neutral with respect to international trade, as they are typically applied on imports and rebated on exports, which means they do not distort the relative prices of domestic versus foreign goods in international markets. This "border adjustment" feature makes them a preferred revenue source in many developed economies globally. While VATs do impose an economic burden by reducing returns to work, which can slightly shrink hours worked and economic output, their overall efficiency gains, particularly concerning investment and trade, are often cited as superior to other forms of taxation.
The fundamental differences between tariffs and a VAT are crucial for understanding their respective economic impacts. While some might conceptually link tariffs to consumption taxes, their design departs significantly from an economically efficient consumption tax like a VAT. Tariffs apply not only to final consumer goods but also to intermediate transactions and raw materials. This means that tariffs effectively burden investment by increasing the cost of inputs for businesses. In some cases, the distortive impact of tariffs on investment can be even greater than that of income taxes. This "tax pyramiding" on intermediate goods leads to higher production costs, reduced competitiveness, and ultimately, higher prices for consumers. Moreover, tariffs distort returns across various sectors and types of investment, leading to capital misallocation as businesses react to artificially altered price signals rather than true market demand.
Beyond their direct economic costs, tariffs carry significant geopolitical consequences. They frequently invite retaliatory measures from affected trading partners, which compounds the economic cost without generating any additional revenue for the imposing country’s treasury. This cycle of protectionism can escalate into trade wars, disrupting global supply chains, reducing international trade volumes, and fostering economic uncertainty worldwide. Such actions can also encourage countries to form trade pacts that explicitly exclude the tariff-imposing nation, further isolating its economy. The executive authority under which many of the recent U.S. tariffs were imposed (e.g., Section 122, Section 301, and Section 232 tariffs) also means they face ongoing legal challenges, adding another layer of instability. For these reasons, tariffs are considered a relatively distortive and economically inefficient type of tax, creating more harm than good in many instances.
Given the inherent distortions and instability associated with tariffs, the Tax Foundation’s analysis suggests that a VAT would cause significantly fewer economic distortions. Their modeling indicates that the estimated $1.8 trillion revenue loss from eliminating all tariffs could be entirely replaced with a broad-based VAT levied at a modest rate of just 1 percent. Crucially, such a revenue-neutral swap is projected to yield substantial economic benefits. The Tax Foundation’s General Equilibrium Model forecasts an increase in overall economic output, a larger capital stock, and more hours worked across the economy. It is important to note that their modeling, by its design, may even understate the potential gains, as it does not fully capture all the distortive effects tariffs have on the cost of capital and the complexity of supply chains. Therefore, the true economic benefits of replacing tariffs with a VAT could be even greater than estimated.
The proposed swap would be revenue-neutral on a conventional, static basis, meaning it would collect the same amount of revenue as the tariffs it replaces without accounting for behavioral changes. However, when considering the dynamic effects – the changes in economic behavior and growth stimulated by the reform – the picture becomes even more favorable. On a dynamic basis, the swap is projected to raise an additional $130.1 billion over the budget window due to the boost in economic activity. This additional revenue contributes to a healthier fiscal outlook. Furthermore, the debt-to-GDP ratio, a critical indicator of fiscal sustainability, would remain virtually unchanged conventionally measured. Dynamically, however, it would see a slight but meaningful improvement, falling approximately 1.3 percentage points from a projected 175.9 percent in 2056 to 174.7 percent. While seemingly small, such improvements compounded over decades can have significant positive impacts on fiscal stability.
From a distributional perspective, a revenue-neutral swap from tariffs to a broad-based VAT is not expected to result in a significant change in who bears the overall tax burden. Consumption taxes, like VATs, are sometimes criticized for being regressive, disproportionately affecting lower-income households who tend to spend a larger share of their income. However, when replacing another indirect tax like tariffs, which also raise consumer prices and disproportionately impact certain industries, the distributional impact of the swap can be more nuanced. Moreover, on a dynamic basis, all income groups are expected to see gains due to the overall increase in economic output and job creation spurred by the more efficient tax system. This means that while direct tax burdens might shift, the broader economic benefits could lead to higher real incomes across the board.
The nation currently finds itself on a perilous path, facing the prospect of record-breaking budget deficits year after year, alongside businesses and workers navigating an environment of profound economic uncertainty. Policymakers are thus confronted with the challenging task of designing policy solutions that can effectively address these dual problems. Rather than perpetuating an administration’s tariff policy, which has proven to be unstable, economically distortive, and legally precarious, there is a compelling case for exploring new solutions. Replacing tariffs with a value-added tax represents a significant policy shift that could generate sustainable revenue with fewer economic distortions, foster greater certainty, and ultimately contribute to a more robust and stable American economy. This moment calls for a forward-thinking approach to tax reform that prioritizes long-term fiscal health and broad-based economic prosperity over short-term, politically expedient, but ultimately unstable, revenue sources. The urgency of the situation demands a thorough and objective evaluation of all available options to secure a more resilient economic future for the United States.
