The Fairy Tale of Returning to a Tariff-funded Government

Note: This is the third article in a multi-part series on teaching economics through today’s ongoing trade war. You can read Part 1 here, Part 2 here, Part 4 here, Part 5 here, and Part 6 here. Stay tuned for more. 

Say what you will about President Trump’s chaotic trade war, but throughout his decades-long career in the public eye, there’s one thing he’s been remarkably consistent on: He loves tariffs. 

“I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so,” the president tweeted in 2018. “Tariff,” lest we forget, is the “most beautiful word” in the English language. Indeed, the self-styled “Tariff Man” has never attempted to hide his love for tariffs. Tariff-philia has been a staple of his political thought dating back to the 1980s, predating his infamous comb-over and signature catchphrase (“You’re fired!”). 

In an earlier installment of this series, we examined the ever-evolving rationales for tariffs. Some are quite easy to shoot down (e.g., tariffs are not a “tax cut”). Others, however, aren’t so easy to debunk. 

This installment tackles one of the more thoughtful claims that President Trump and other modern Mercantilists make about today’s trade war: if tariffs are so bad, why did the U.S. economy enjoy such rapid growth in the 19th century when they were its primary source of tax revenue?

The Tariff Man: Strong-manning the President’s Historical Argument for Tariffs

To their credit, this argument contains a kernel of truth. Tariffs were, in fact, the primary source of revenue for the federal government during the Founding Era, and they remained as such for most of the first 150 years of American history as the U.S. emerged to become an economic superpower.

Between the ratification of the Constitution and the Civil War, tariffs accounted for approximately 80 to 95 percent of federal revenue. Though these ratios dipped during the Civil War with the introduction of a variety of excise taxes (and even a short-lived income tax) to help pay for the war effort, tariffs regained their footing as the Treasury’s primary revenue source in the post-Civil War era, accounting for roughly 50 to 60 percent of its revenue in the decades leading up to the passage of the 16th Amendment in 1913, which established the federal income tax. 

It’s also true that economic growth was, indeed, quite robust throughout this era. Real GDP grew by roughly 3.5 percent per year between 1789 and 1913, helping the U.S. surpass the United Kingdom as the world’s largest economy by the turn of the 19th century. Not all of this was the result of extensive growth caused by territorial expansion and a rising population. Much of it was due to intensive (i.e., productivity) growth caused by technological advances and, inconveniently for today’s protectionists, the advanced division of labor that was made possible by a 15-fold increase in foreign trade during this period. GDP per capita grew by roughly 1.5 percent per year over this period, as the average household’s earnings rose from roughly $1,250 in 1789 to $5,300 in 1913 (measured in 2012 dollars). 

Given the apparent success of this regime, critics of tariffs must answer two objections from today’s Mercantilists. First, if tariffs were good enough for our Founders to adopt and their successors to maintain for nearly 150 years, why shouldn’t we rekindle them today? President Trump has even mused that we could use the tariff revenue collected by his proposed External Revenue Service to replace income taxes. Second, if tariffs are such a drag on the economy, why did the U.S. enjoy such strong growth throughout this prolonged era where tariffs were the Treasury’s primary funding source?

The Tariff Myth: Tariffs Cannot Fund Our 21st Century Federal Government

Why shouldn’t we revive the tariff-funded system of government that our Founding Fathers established? After all, our Founders were smart. They designed a government primarily funded by tariffs, not income taxes. Surely, they wouldn’t have built a government on such a shoddy foundation. Besides, no one likes Tax Day. So why not “86” the income tax and replace it with the tariff regime of yesteryear? 

The simple answer is that it was a much simpler time, at least in terms of what was required to fund our early Republic’s government. To put it plainly, tariffs were only a feasible source of tax revenue back then because the federal government of yore was a tiny fraction of today’s leviathan. 

Throughout the 19th century, federal spending comprised only 2 to 4 percent of GDP. In 1800, for instance, the federal government comprised less than 2.5 percent of GDP and spent $10.8 million, roughly $300 billion in current dollars. In 2024, the federal government comprised 25 percent of GDP, or roughly $7 trillion. In the early Founding era, the federal government had just five agencies or departments (the Departments of State, Treasury, War, the Attorney General’s Office, and the Post Office). Today, it has more than 500 agencies and departments. If the early Republic’s government could sustain itself on the diet of a tiny minnow, today’s requires a killer whale’s diet. 

The composition of federal spending has also changed dramatically. Today’s biggest spending drivers are non-discretionary entitlement programs—Social Security, Medicare and Medicaid, spending on which topped $4.1 trillion in 2024. None of these programs existed during the tariff era, nor would they be remotely feasible to fund with the relatively meager revenue that tariffs could reel in. 

The next largest spending driver and our largest discretionary budget item today is military spending. In 1800, military spending was roughly $2.5 million, accounting for less than 0.5 percent of GDP. Today, it’s nearly $1 trillion, or roughly 3.5 percent of GDP. Yet again, it’d be mathematically impossible for tariffs to raise enough revenue to finance anything remotely resembling our modern military, much less the entire federal budget for FY2025. The reason is straightforward for anyone who is familiar with the Laffer Curve. To raise revenue, tariff rates need to be low enough to allow for a steady flow of imports. Financing the entire federal budget with tariffs would require higher tariff rates.

Higher tariffs, however, discourage imports, shrinking the potential tax base. Drastically raising tariffs would effectively staunch the flow of imports, thereby reducing the amount of revenue they can bring in. Hence, the Catch-22 of tariff policy: higher tariffs can only raise revenue up to a point, beyond which they actually decrease revenue. (For more on this, see our previous article.) 

Upon closer scrutiny, our Founding Fathers didn’t share a deep affinity for tariffs, nor did they think tariffs were some secret sauce for economic prosperity. They imposed tariffs out of necessity, not desirability. In the founding era, there were no planes, trains, and automobiles delivering goods from abroad—only ships. Collecting what was effectively a small toll on foreign ships was a simple way to raise revenue. Income taxes? Not so much, especially in an age before the IRS or digital withholding. 

Nixing income taxes in favor of tariffs may sound enticing to many Americans (especially after Tax Day).

But unless the administration is willing to slash entitlement spending, disband our standing army and return us to a world of dirt roads and private militias, replacing income taxes with tariffs is a fiscal nonstarter. Economists’ opposition to reverting to a tariff-based tax system isn’t ideological—it isn’t rooted in free market dogma. It’s rooted in basic arithmetic. The numbers just don’t add up. 

In the next article in this series, we’ll examine the second objection that tariff opponents must address: if tariffs are so bad, why did the American economy experience such rapid growth during this heyday of tariffs in the 19th century?