States most exposed
Economists examining the president’s idea have identified a small group of states whose finances could prove especially vulnerable. California and New Jersey illustrate two distinct pathways of exposure: heavy reliance on personal income taxes and heavy dependence on revenues already earmarked for long-term obligations. Though other states would also face challenges, these two stand out in current analyses based on available data.
California: reliance on high-income taxpayers
The nonpartisan California Budget & Policy Center reports that personal income tax accounts for the largest share of the state’s General Fund. Because California employs a highly progressive rate structure, a significant portion of that revenue is paid by residents in the top income brackets. Capital-gains realizations, bonuses in the technology sector and other volatile sources of earnings make collections especially sensitive to economic cycles.
The Governor’s Budget Summary for fiscal year 2025-2026 estimates that more than two-thirds of General Fund revenue comes from personal income taxes. When those taxpayers change investment strategies or realize fewer gains, receipts fall quickly. A large federal policy shift that lowered or eliminated federal income-tax obligations could alter taxpayer behavior—such as the timing of sales of appreciated assets—in ways that ripple through state coffers even if California’s own tax code remains intact.
Analysts at the Pacific Research Institute have long argued that this concentration elevates risk during downturns or any federal action that reshapes incentives. Without sizable consumption taxes or revenue from natural-resource extraction to absorb shocks, California would have less room to maneuver in the event of sudden shortfalls.
New Jersey: fixed costs and limited flexibility
New Jersey’s situation differs. S&P Global data show that the state carries some of the nation’s largest unfunded pension liabilities and significant retiree health-care obligations. Those commitments consume a growing share of annual appropriations, leaving lawmakers limited options if revenue slows.
Even modest reductions in collections can trigger outsized consequences when so much spending is effectively mandated. Pew Charitable Trusts researchers note that states with high legacy costs have little fiscal agility compared with peers that maintain lighter long-term commitments. Should federal income-tax policy change and influence household behavior—such as shifts in deductible contributions or retirement planning—New Jersey could see revenue pressure almost immediately.
To cover any gap, the state might need to trim services, raise alternative taxes or postpone scheduled pension contributions, each of which carries economic and political risks. The problem is compounded by New Jersey’s already high property-tax rates, which limit policymakers’ willingness to lean further on local levies.
Tariffs as a revenue substitute
For tariffs to replace the roughly $2.2 trillion generated by individual income tax, duties on imports would have to expand well beyond current levels. The U.S. collected about $80 billion in customs duties in fiscal 2024, according to the Treasury Department’s Monthly Statement of Receipts. Achieving parity would require either a dramatic increase in the volume of taxed imports, substantially higher tariff rates, or both.
Economists from across the ideological spectrum contend that such an increase could raise consumer prices, provoke retaliation from trading partners and potentially reduce the very import volumes that generate the revenue. Those dynamics make it difficult to model a scenario in which tariff receipts reliably match or exceed present income-tax collections.
Legislative and constitutional hurdles
Eliminating or substantially cutting the individual income tax would require congressional approval. The U.S. Constitution grants Congress the power to lay and collect taxes, and the Sixteenth Amendment authorizes income taxation. Any repeal would likely need either a two-thirds vote in both chambers followed by ratification from three-quarters of the states or an alternative mechanism that leaves the amendment in place but replaces statutory rates with zeros. Either path faces steep political odds.
Implications for state budgeting cycles
States craft budgets on a one- or two-year cycle and rely on forward revenue estimates derived partly from historical patterns under the existing federal code. A fundamental shift in that code would arrive mid-cycle for many jurisdictions, potentially forcing special legislative sessions, emergency borrowing or rapid spending cuts.
Fiscal analysts warn that credit-rating agencies could reassess state debt if large sources of revenue become unstable. California and New Jersey already pay interest-rate premiums tied to their revenue volatility and pension obligations; greater uncertainty could widen those spreads, raising borrowing costs for infrastructure and other capital projects.
Next steps
At present, the White House has not released formal legislative text outlining how tariff receipts would supplant income-tax collections or how federal transfers to states would be maintained. Treasury officials say they are reviewing potential revenue scenarios, but no timeline for public release has been announced.
Meanwhile, budget directors in affected states are running contingency models to gauge potential exposure. For California, the exercise centers on possible swings in high-income filings and capital gains. For New Jersey, planners are mapping scenarios in which even small revenue dips could upset long-term pension funding schedules.
While the proposal remains speculative, state officials and economists agree that any move to replace the federal individual income tax with tariffs would bring significant fiscal uncertainty. Until more details emerge, budget preparations in the most exposed states will likely emphasize reserves, diversified revenue strategies and close monitoring of federal deliberations.
Crédito da imagem: Kerra Bolton
