One of the recurring elements in the dispute over President-Elect Trump’s proposed tariffs is confusion over who actually pays for them. Fans of Trump claim that it is the foreign companies selling imports into the United States, while foes of Trump claim that it is American consumers who ultimately bear the burden.
In reality, the answer is that it is some mix (though empirically the literature comes down on the side of domestic consumers shouldering most of the cost, at least in the case of the 2018 tariffs). However, in this post I want to clarify that the answer depends on the relative ability of the American consumers versus the foreign producers to shift to alternatives. (Economists call this the “elasticity” of supply and demand.) It is completely irrelevant of the actual mechanics of the tariff: Whether it is directly levied on the foreign producer, or instead is a surcharge paid by the domestic importer, the “sticker price” simply adjusts to render the same outcome.
I will illustrate this phenomenon with a simple example.
A Best Buy Example
Suppose there is a gadget at Best Buy with a sticker price of $100. Then the government imposes a sales tax of a flat $10 (i.e. it’s not a percentage). Does the consumer or the producer end up paying the tax? You might think it depends on how the tax is levied, but that logistical detail is irrelevant.
Scenario #1: The Consumer Has No Good Alternatives and Eats the Tax
First let’s consider the scenario where the consumers are addicted to this gadget, and they will buy basically the same amount from Best Buy regardless of any reasonable price hike. In this case, the consumers will bear the burden of the new tax. This is true, regardless of how it’s collected.
For example, if the government tells the store, “Whatever the sticker price is, slap on an extra $10 and make the customer pay that too,” then the sticker price remains at $100, and the consumer pays $110 out of pocket. The Best Buy employee sends $100 to the manufacturer, and the other $10 to the government. (We’re ignoring Best Buy’s markup for simplicity.) It’s clear that the customer eats the tax.
But suppose instead the government tells the store, “We don’t want to burden the consumer. Whatever the sticker price is, that’s what the customer pays. Then out of that, take $10 and send it to us, and only give the balance to the manufacturer.”
However, given our assumption in this scenario that the consumer is desperate for this product, what happens in this new twist is that the sticker price rises to $110. So the consumer “only” pays the sticker price, but this is now $10 higher than it would be in the absence of the tax. The consumer still pays $110 out of pocket, and the manufacturer still nets $100, so it’s clear that here too, the consumer bore the full burden.
Scenario #2: The Producer Has No Good Alternatives and Eats the Tax
Now let’s switch it up, and suppose that the producer is willing to sell the same number of units to Best Buy, regardless of reasonable price movements, and the consumer is very sensitive to price. In this case, it doesn’t matter how the tax is levied, the producer ends up eating it.
For example, if the government says, “Just have the shopper pay the sticker price, and take out $10 for us and only give the balance to the manufacturer,” then in our new scenario the sticker price remains at $100. The consumer pays that, and the manufacturer only nets $90 per unit sold. Clearly the producer ate the tax here.
However, even if the government says, “We don’t want to burden manufacturers, so whatever the sticker price is, slap on the extra $10 and make the customer pay it,” this will backfire. Given our new assumption that the producer is the one with no alternatives, what happens here is that the sticker price falls to $90. Then the consumer pays $100 total out of pocket, and the manufacturer nets $90. So again, even if the government tries to force the consumer to pay the new tax, prices can adjust if that’s the reality of the underlying elasticity of supply versus demand.
Conclusion
To repeat, empirically it seems that in general, domestic consumers end up paying the lion’s share of a tariff. However, this really is a matter of specific goods and specific trading partners. And the takeaway point I’m making in this post is that the official party responsible for paying the tariff is utterly irrelevant. Pre-tax prices adjust, so that the true burden is borne by the party whose supply or demand is relatively inelastic. In practice, this will result in the tariff being shared by both sides, but the more inelastic side will carry more of the burden.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.
Twitter: @infineogroup, @BobMurphyEcon
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