Tariffs have long served as a prominent instrument in American trade policy, but their role in federal revenue collection has undergone a dramatic transformation over the past several years. Under tariff increases implemented by President Donald Trump beginning in 2018, tariff revenue has more than tripled as a share of the Gross Domestic Product (GDP). However, this new stream of income has proven remarkably unstable. Many of these sweeping levies were enacted using untested legal authorities, leaving them vulnerable to intense judicial scrutiny that culminated in the Supreme Court striking down key measures in February 2026.
As the federal administration works to craft replacements for the invalidated levies, fiscal policy experts and lawmakers face mounting pressure to devise a coherent alternative. The core challenge lies in navigating the dual threats of persistent economic uncertainty and a worsening long-term fiscal instability. Even with the influx of revenue generated by the recent tariffs, the broader trajectory of the United States federal budget remains alarming.
According to long-term projections, annual budget deficits are on course to exceed $2 trillion within just a few years, ultimately climbing past $3 trillion by the end of the budget window in 2036. Concurrently, the cost of servicing the national debt is skyrocketing. Interest payments alone are projected to surpass $2 trillion by 2035, meaning that servicing the debt will soon cost more than the entire national defense budget and nearly match the outlays for major entitlement programs like Medicare.
These pressing concerns are the focal point of a new publication from the Tax Foundation, titled Options for Reforming America’s Tax Code 3.0: A Policymaker’s Guide to Tax Reform Trade-Offs. The book models a comprehensive tax reform scenario that would eliminate all the new tariffs enacted since 2018 and return U.S. trade policy to its 2017 baseline. While removing these tariffs would successfully alleviate the severe economic burdens they impose on businesses and consumers, it would simultaneously blow a massive hole in the federal budget, exacerbating already high deficits.
When the initial modeling for the book was conducted, the full scope of the tariff regime was not yet realized. Since publication, additional levies have taken effect, prompting updated estimates. Analysts now calculate that repealing all the new tariffs—including those dating back to the first Trump administration—would cost the federal government nearly $1.8 trillion in forgone revenue between 2027 and 2036. At the same time, removing these trade barriers would reduce marginal tax rates on work and investment across the United States, driving an increase in overall economic output and hours worked.
To responsibly offset this substantial loss of revenue without resorting to damaging fiscal measures, lawmakers could consider introducing a value-added tax, commonly known as a VAT.
A value-added tax is a form of consumption tax collected on the incremental value added at each distinct stage of the production cycle for a good or service. While it functions similarly to a retail sales tax by ultimately burdening only final consumer goods, it is administered dynamically along the supply chain during production rather than exclusively at the point of final sale.
Most modern economies administer a VAT through a credit-invoice system. Under this framework, businesses collect tax on their gross sales at every stage of production but receive a tax credit for the levies they already paid on their intermediate inputs. This mechanism effectively strips the tax burden away from intermediate business-to-business transactions, concentrating the tax exclusively on the final retail sale.
A key economic advantage of this structure is that a VAT is neutral between consumption and saving. Unlike the traditional U.S. income tax system, which can discourage capital formation and investment, a fully transitioned VAT imposes no tax burden on the normal return to investment—defined as the baseline return required just to break even. It leaves taxes focused instead on supernormal returns, which exceed the normal return and typically arise from market power, rent-seeking, innovation, or investment risk. Furthermore, a VAT remains broadly neutral with respect to international trade and various categories of capital investment, though it does still carry some economic burden by reducing the net returns to work, which can slightly depress hours worked and overall economic output.
Although tariffs are frequently discussed by policymakers as a form of consumption tax, they diverge sharply from sound consumption tax design in critical ways. Unlike a VAT, which protects intermediate transactions from taxation and avoids penalizing normal investment returns, tariffs directly burden investment. In certain sectors, the economic penalty imposed by tariffs on capital investment exceeds the burdens created by the corporate income tax.
Furthermore, tariffs notoriously distort returns across different economic sectors and types of capital investment, inevitably leading to a misallocation of resources. Unlike domestic taxes, tariffs also carry profound geopolitical consequences. They routinely invite retaliatory trade measures from international partners, compounding the economic drag on the U.S. economy without generating any additional revenue for the Treasury. They may also incentivize foreign trading partners to pursue exclusive trade pacts that deliberately bypass and isolate the United States. Due to these compounding factors, tariffs represent a uniquely distortive tax instrument. This distortion is further amplified by the fact that the recent wave of tariffs was instituted entirely under executive authority—utilizing provisions such as Section 122, Section 301, and Section 232—keeping them mired in ongoing legal battles and regulatory unpredictability.
Given these structural shortcomings, transitioning to a broad-based VAT would introduce significantly fewer distortions into the economy than maintaining a tariff-reliant trade strategy. Economic modeling indicates that the substantial revenue loss resulting from the total elimination of the new tariffs could be fully replaced by a broad-based VAT levied at a modest rate of 1 percent. Crucially, this fiscal swap would simultaneously expand economic output, grow the domestic capital stock, and increase total hours worked. Because standard modeling frameworks often fail to fully capture the hidden distortive costs that tariffs inflict on the cost of capital, the actual economic gains of replacing tariffs with a VAT could prove even greater than projected.
Evaluated on a conventional basis, the proposed tax swap would be entirely revenue neutral. However, when accounting for the dynamic economic feedback effects—such as the boost in overall output—the reform would generate an additional $130.1 billion in revenue for the federal treasury over the standard budget window. Viewed through a conventional lens, the national debt-to-GDP ratio would remain virtually unchanged, but dynamically measured, the long-term debt trajectory would improve slightly, falling by roughly 1.3 percentage points from 175.9 percent down to 174.7 percent by 2056. Distributional analysis indicates that a revenue-neutral swap would not radically alter the overall progressivity or distribution of the tax burden. Moreover, on a dynamic basis, households across all income brackets would experience financial gains driven by the broader expansion of the national economy.
As the United States contends with the prospect of record-breaking annual budget deficits and an increasingly volatile trade and economic environment, policymakers are forced to confront difficult trade-offs. Rather than perpetuating an unstable and legally contentious tariff regime, lawmakers have viable alternative paths available. By exploring sustainable, low-distortion revenue mechanisms such as a value-added tax, the federal government can secure the funds necessary to stabilize its long-term fiscal outlook while fostering a more resilient and productive domestic economy.
