Trump's External Revenue Service Ruse

Channeling William McKinley, Trump's executive order on "America First Trade Policy" features a ludicrous proposal to establish an "external" version of the Internal Revenue Service.

It is impossible to predict outcomes of a random walk. Yet that is the very task that awaits us as we try to make sense of another Trump era. The only point I would dare to venture in these early days is that Trump 2.0 is starting off where Trump 1.0 ended — with distortions, convoluted logic, and the related risk of major policy blunders. All we really know about this version of a Trumpian future is what we see today. While that is hardly a predictive insight, it gives you a sense of what we analysts are up against.

I could pick any one of a number of actions taken by Donald Trump on the first day of his second term to underscore this point, but his executive order on America First Trade Policy quickly caught my economist’s eye. It touches on topics I have writing about for years — trade deficits, unfair trading practices, currency alignments, and, of course, tariffs — and it bears critically on the US and global economic outlook. Rather than rehash these timeworn arguments, I single out Section 2(b) of this executive order — Trump’s proposal to establish a so-called External Revenue Service. The clever name for a companion agency to the Internal Revenue Service, the ERS would purportedly serve as a repository for the vast amount of tariff revenue to be collected from America’s foreign trading partners that could be used to support Trump’s ambitious MAGA agenda. The idea is beyond ludicrous.

My argument hinges on a pretty conventional view on the basic definition and revenue estimates of tariffs. Tariffs, or customs duties, are a tax on foreign produced goods sold in the United States, with revenue collected from importers at the port of entry into the US. Yes, under Trump 1.0, tariff revenues increased dramatically (see figure below). The US Customs and Border Protection has collected an average $79 billion in tariffs per year since the onset of the tariff hikes in 2018, more than double the $37 billion in tariff collections from 2013-17; even so, total tariff collections have accounted for just 1.8% of total federal receipts since 2018. Over the next decade, 2025-34, the Congressional Budget Office estimates that cumulative revenue from tariffs would amount to $872 billion, or about 1% of total federal revenues over that period. If that’s the revenue pool that Trump dreams of tapping as a source of ERS funding, he has overlooked one critical consideration: tariff revenues are collected from domestic US companies who do the importing, not from foreign producers who do the exporting.

The ERS funding issue is, of course, tangential to the long contentious debate over the potential impacts of tariffs. Do US importers absorb the cost of the tariff hikes and reduce their profit margins accordingly? Or do importers pass on the tariff hikes in the form of higher prices to US consumers? Or do importers push back on foreign producers, forcing them to lower their margins to maintain market share in the US? Or, more likely, is it a combination of all the above? Irrespective of how these questions are answered, that doesn’t change the basic point stressed above: Tariffs are still collected from US companies that import foreign-made goods into the United States. The US Treasury has no statutory authority to collect revenue directly from foreign-domiciled enterprises that export to the US.

Of course, there is an added wrinkle to Trump’s tariff strategy — the idea that the bark is more lethal than the bite. The point here is that just the threat of additional tariff hikes may prompt concessions on other policies from America’s trading partners. Trump has been transparent on this point, warning Canada and Mexico, for example, of 25% tariffs by February 1 if they don't alter their practices on US border security and/ or fentanyl trafficking. He has made additional tariff threats on China, pressuring Beijing on fentanyl and/ or a deal on TikTok. Even if America’s trading partners flinch in response to Trump’s pressure, my basic point remains unaltered: the External Revenue Service would still lack a source of funding.

Current media spin, both in the US and China, would lead you to believe that a deal-focused Trump is now going much easier on China than he threatened during the election campaign. Recent telephone conversations between Xi and Trump, along with growing rumors of an early leader-to-leader summit, have reinforced this impression.

I have my doubts. As noted above, Trump’s ERS proposal is one piece of a very broad executive order on trade policy that covers a wide range of additional areas — from trade deficits and currency manipulation to technology transfer and unfair trading practices (such as subsidies and discriminatory extraterritorial taxes). It also challenges compliance of existing trade deals, such as the USMCA with Mexico and Canada, and it weighs in on several of the most contentious issues with China, including the 2020 “Phase I” deal, China’s Permanent Normal Trade Relations status, and allegations of intellectual property theft and supply-chain risks.

In many respects the comprehensive scope of the new executive order on trade policy is very reminiscent of the broad instructions that Trump issued in 2017 to Robert Lighthizer, his first US Trade Representative. It is important remember how this played out: The honeymoon of 2017 ended up being the lull before the storm of a US-China trade war that is still raging today.

If anything, Trump 2.0 doubles down on the central role that tariffs play in a new America First trade policy. It’s not just Donald Trump’s “beautiful word” endorsement offered during the campaign, but it is a revisionist sense of US economic history that celebrates William McKinley, who as 25^th president embraced both tariffs and the territorial expansionism of “manifest destiny” in the late 19^th century. Yes, prior to ratification of the 16^th amendment of the Constitution in 1913 that granted the US Congress the power to collect personal income taxes, tariffs were a major source of Federal revenues (see chart above). But the inflationary impact of the McKinley precedent is at odds with the 47^th president’s commitment to reducing prices; nor is there any real need to protect America’s “infant industries” as there was back then. Additionally, there is widespread recognition of the pitfalls of the “meddlers trap” associated with McKinley’s annexation of the Philippines in 1898 — a lesson that bears directly on Trump’s absurd adventurist ambitions regarding Greenland, the Panama Canal, and even Canada.

Equally ludicrous, Trump’s McKinley fixation is also reflected in yet another executive order that changes the name of Denali, North America’s highest mountain and a sacred peak for indigenous Koyukon Alaskans, back to Mount McKinley. For what it’s worth, McKinley, apparently one of Trump’s personal heroes, was ranked 22^nd out of 44 unique presidents by the 2022 Siena College Survey of leading historians, political scientists, and presidential scholars — basically in the middle of the pack but well above Trump who came in near the bottom at 43^rd place in his first term.

Donald Trump’s style of governance is emblematic of a dangerous personalization of American policy.From blanket pardons of insurrectionists and termination of birthright citizenship to US withdrawal from the Paris Climate Accord and the World Health Organization, Trump’s performative shock and awe is less a reflection of a thoughtful consultation with expert advisors and more a marketing strategy for his brand as the great disruptor. That applies to trade policy in both his first administration and what is likely to lie ahead as Trump 2.0 unfolds. The ERS funding ruse is a case in point. As Donald Trump famously warned in a 2020 presidential debate, “stand back and stand by.”