The competing tax proposals from Vice President Kamala Harris and former president Donald Trump serve as a reminder that how we choose to raise tax revenue can have vastly different consequences for the economy. Both candidates propose trillions of dollars in new taxes as part of their fiscal plans, but Harris prefers to lean on corporations and the wealthy to boost the government’s coffers, while Trump prefers taxing our purchases of foreign goods with higher import tariffs. Whatever one thinks about the effects of taxes on economic growth, it would be a mistake to skip the step of weighing the trade-offs of each candidate’s approach.
To better understand the trade-offs, we at the Tax Foundation use our General Equilibrium Model to illustrate how taxes affect key economic drivers like investment and employment. Our model simulates how a tax policy modification would change the returns to capital and labor and, in turn, how these changed incentives reverberate throughout the economy.
When we model a change in tax policy, the estimated effect on economic output is not a reflection of the amount of revenue raised or lowered—that is, it’s not a simple “tax cuts good, tax hikes bad” formula. Instead, the economic impact reflects how the change in tax policy alters the after-tax return to capital and labor, as well as incentives to work, save, and invest on the margin.
Some taxes create more economic losses than others, either by falling more on mobile factors of production (like the corporate income tax falling on capital) or by causing greater distortions along some other margin (like tariffs inviting foreign retaliation). Regardless of spending plans, estimating the effects of tax policy changes helps us judge whether policymakers have identified efficient ways to raise new revenues.
Let’s take a look at Trump’s preferred method: tariffs. We model tariffs as an excise tax (a narrowly targeted consumption tax), which creates a wedge between a person’s earnings and how much consumption a person can afford after tax. This effectively reduces real after-tax wages, consequently discouraging work and leading to lower economic output.
We estimate that Trump’s proposed 20 percent universal tariff, coupled with his additional levies on China to bring the current 10 percent tariff up to 60 percent, would shrink U.S. GDP by 1.3 percent in the long run, while even partial foreign retaliation would result in another 0.4 percent drop in long-run GDP. We’ve also estimated that the trade war tariffs that Trump imposed in 2018 and 2019 (and that Joe Biden retained) will reduce long-run output in the United States by about 0.2 percent. Empirical studies on the 2018–2019 tariffs reinforce our projection, with estimated effects on U.S. output ranging from -0.17 percent to -0.50 percent. Further, economists have explained that “the tariffs are particularly costly relative to many other public policies.”
While tariffs are highly distortionary, Trump’s other revenue-raising proposals, such as repealing the temporary green energy tax credits and broadening the income tax base by limiting itemized deductions, are less damaging. Compared with tariffs, broadening the tax base by eliminating narrowly targeted provisions offers a more efficient way to raise revenue.
Harris has blasted Trump’s tariffs on the campaign trail, but her alternative proposals don’t bode well, either. We estimate that Harris’s tax changes would reduce long-run GDP by 2.0 percent, largely driven by her plan to raise the corporate income tax rate to 28 percent. By reducing capital accumulation, corporate income taxes have the steepest economic trade-off per dollar of revenue raised.
It’s not just the Tax Foundation model that illustrates how some taxes are more efficient than others. A landmark study from economists at the Organisation for Economic Co-operation and Development reached similar conclusions, noting that a “revenue neutral growth-oriented tax reform” would shift the tax mix away from income taxes to less distortionary forms of taxes. Several additional studies suggest that income-tax base-broadening and well-structured consumption taxes, such as value-added taxes or environmental taxes, are relatively efficient revenue raisers.
By relying on inefficient revenue sources—whether tariffs or higher corporate taxes—both candidates risk creating unnecessary economic harm. Paying attention to the trade-offs of different types of taxes would help policymakers identify smarter, less distortionary revenue sources to fund government.
Photos: Ian Maule/Getty Images (left) / MANDEL NGAN/AFP via Getty Images (right)