The answer to the question “Who pays the cost of tariffs?” is obviously important. If the costs of all tariffs were paid exclusively by foreigners, with no negative consequences suffered by citizens of the country that imposes the tariffs, the case for a policy of free trade would be far weaker than if tariffs inflict some damage on the domestic economy. Ethical objections to tariffs would still be available, but the conventional economic case against protective tariffs would be null and void, as that case focuses almost exclusively on the economic welfare of citizens of the home country.
Yet the costs of tariffs are always shared by buyers and sellers of tariffed goods and services. This inevitability springs from the fact that all trade is mutually advantageous. Because tariffs prevent some trades from occurring that would otherwise occur absent the tariffs, both parties to the obstructed trade suffer. In some cases, would-be buyers suffer more than do would-be sellers, and in other cases the bulk of the suffering is inflicted on would-be sellers. But in all cases, tariffs inflict harm on both parties.
The Simple Analytics of the Tax Called “Tariffs”
Whether intended to raise revenue or to protect domestic sellers from foreign competition, tariffs are a tax. In practice, the legal obligation to pay this tax is imposed on importers, who are middlemen between the foreign suppliers and the domestic buyers. If we think in terms of suppliers and buyers – of supply and demand – we can helpfully simplify just a bit by thinking of tariffs as a tax formally obliged to be paid by suppliers. The higher the tariff, the higher the cost to suppliers of supplying any given quantity of the good or service in question. From the suppliers’ perspective, a tariff is simply another cost of doing business – a cost that must be covered no less than does the cost of labor and of other inputs into the production process.
Suppliers, of course, would love to offload the entire cost of the tariffs onto buyers. For example, if the tariff on imported apples is $1 per pound, and the pre-tariff price of apples is $2 per pound, sellers of imported apples would love to raise the price of apples to $3 per pound so that the amount of revenue ($2 per pound) that sellers of imported apples clear with the tariff remains the same as what they cleared before the tariff was imposed. And a naïve person might suppose that this is just what sellers of tariffed apples do.
But the naïve person, unsurprisingly, is mistaken. The apple sellers, although legally allowed to raise the price they charge for a pound of apples from $2 to $3, aren’t economically allowed to do so. The reason is that apple buyers purchase fewer apples as the price of apples rises.
Suppose that before the tariff, with the per-pound price of imported apples being $2, sellers of these apples sold – and, hence, buyers bought – 1,000 pounds each week. If, when a $1 per-pound tariff is imposed, these sellers raise their asking price to $3 per pound, buyers will obviously purchase some amount less than 1,000 pounds. Let’s say that the weekly amount buyers will purchase at $3 per pound is 550 pounds. At $3 per pound, sellers produce and offer for sale 1,000 pounds each week but buyers purchase only 550 pounds.
What are sellers to do in the face of this surplus of apples? The answer is to lower the price in order to entice buyers to purchase more than 550 pounds.
Let’s say that the price falls to $2.60 per pound, and at this price buyers purchase 800 pounds each week. For two reasons, buyers are worse off than before the tariff. First, buyers now pay 60 cents more for each pound of apples that they buy. Second, buyers get and consume 200 fewer pounds of apples each week.
What about the sellers of the imported apples? After handing to the customs agents $1 for each pound of apples that they import and sell, sellers are left with $1.60 for each pound of apples sold, which is 40 cents per pound less than they cleared before the tariff. It’s because they earn less per-pound sold with the tariff than without the tariff that suppliers of imported apples are willing now to supply only 800 pounds per week instead of the 1,000 pounds they willingly supplied before the tariff was imposed.
And so the apple sellers, like the apple buyers, are worse off because of the tariff in two ways. The sellers receive 40 cents less for each pound sold, and they sell 200 fewer pounds of apples each week, missing out on the profits they obviously earned on the pre-tariff sale of those 200 pounds.
The government, however, now rakes in weekly customs revenue of $800: 800 pounds of apples are imported each week with a $1 tariff charge collected on each pound.
Two Different Manifestations of Tariffs’ Costs
Discussions of who pays the tariffs too often focus exclusively on how much of the customs revenue is paid by buyers (in the form of paying more out of pocket for the imports) and how much of this revenue is paid by sellers (in the form of clearing less money on each unit imported and sold). In the above hypothetical example, analysts would conclude that 60 percent of the tariffs’ costs are paid by buyers while 40 percent of these costs are paid by importers. Of the weekly customs revenue of $800, buyers pay a total of $480 ($0.60 X 800) and importers pay $320 ($0.40 X 800).
The detailed distribution of this cost of the tariff between domestic citizens (buyers) and foreigners (sellers) is determined, as we economists say, by the relative elasticities of demand and supply. The less responsive are domestic buyers to increases in the prices of tariffed imports, the greater is the ability of foreign suppliers of tariffed goods to offload onto these buyers, in the form of higher prices, some of the costs of the tariffs. It follows that the less responsive are domestic buyers to increases in the prices of tariffed imports (relative to the responsiveness of foreign suppliers to their receipt of less revenue per unit sold), the greater is the share of the customs revenue paid by domestic citizens and the lesser is the share paid by foreigners.
If the above jargony paragraph is indecipherable, no worries. The larger point is that customs revenues are always paid in part by foreign suppliers and in part by domestic citizens.
But to focus exclusively on what portion of the customs revenue is paid by domestic citizens and what portion is paid by foreigners is to lose sight of the losses suffered by both groups as a result of selling and purchasing fewer units of tariffed goods.
This oversight is significant. To see why, consider the extreme case in which foreign suppliers ‘eat’ the entire dollar cost of the tariffs. Foreign apple growers, hit with a $1 per-pound apple tariff, absorb this entire tariff amount by lowering the pre-tariff per-pound price they charge from $2 to $1. One dollar per pound is paid to the customs house by foreign apple suppliers, leaving only $1 being cleared by these suppliers. Every cent of the customs revenue is paid by foreigners. “Hooray!” cheer American economic nationalists. “The tariffs cost us nothing!”
But the economic-nationalists are mistaken. Because foreign apple sellers now clear, for each pound of apples sold in the US, only $1 instead of the $2 they cleared before imposition of the tariff, the amount of apples these sellers will supply to Americans will not only fall, it will fall by more than if some of the tariff costs were paid by Americans.
The resulting decrease in the supply of apples in the US will raise the price charged by the apple importers, as well as by domestic apple growers. Despite the dramatic fall in the price charged by foreign apple growers, Americans will purchase and consume fewer apples than they would have purchased and consumed absent the tariff. The resulting loss in consumer welfare is real despite not showing up in any accounting statement. The books at the customs house will show that every cent of the customs revenue is paid by foreigners, leading pundits and politicians to wrongly conclude that the tariffs cost Americans nothing. Yet the diminished consumption of apples, as well as the diversion of more American resources into apple growing and away from other, more-productive uses, are very real costs of this tariff.
Another point: Even if every cent of the US customs revenue is paid by Americans, with none being paid by foreigners, the dollar value of what Americans pay to the customs house is still less than the full cost to Americans of the tariffs, for this dollar amount doesn’t include the value to Americans of the apples that the tariffs prevent them from consuming.
While some tariffs hit foreigners harder than do other tariffs, there’s no tariff that will not impose real costs on domestic citizens. And this reality holds regardless of the portion of customs revenue paid by foreigners relative to the portion paid by domestic citizens.
