Who pays for tariffs?

Note: this is basically the transcript of a video I recently made explaining how to think about who pays for tariffs.

There seems to be a lot of confusion about who actually pays for tariffs. Part of this confusion comes from focusing on who writes the check rather than who ultimately bears the cost. But as with other taxes, the two are not always the same.

Take the sales tax, for example. Technically, stores are the ones responsible for sending sales tax payments to the government. But stores pretty much always pass that cost on to consumers, so they are not bearing the cost of the sales tax. The same principle applies to tariffs.

If a foreign producer faces a tariff, they have a few options: They can absorb the entire cost themselves to keep prices stable for U.S. buyers. Alternatively, they can pass the full cost of the tariff onto U.S. buyers by raising prices. Most likely, what they will do is split the cost, reducing their pre-tariff price somewhat while still increasing the final price for consumers.

So how can we know who will bear most of the cost of a particular tariff? The answer depends on supply and demand conditions in that particular market. If foreign producers can easily shift their goods elsewhere, for example, they have little incentive to lower their prices just to stay competitive in the U.S. market. Instead, they’ll pass most of the tariff burden onto U.S. buyers. Many firms also operate on thin profit margins, meaning they simply can’t lower their prices without losing money. Finally, if foreign producers dominate the industry (e.g., certain electronics, specialized machinery, or rare raw materials), they may have enough pricing power to pass on most of the tariff costs without losing many customers.

The demand side matters too. If consumers place a lot of value on the good regardless of price, they will bear more of the cost. If they can easily switch to comparably-priced alternatives, foreign producers will be forced to absorb more of the tariff. When I say consumers, I’m also including U.S. firms that rely on imported goods as inputs for their own production. If these firms face higher input costs due to tariffs, they will likely pass at least some of those costs on to their customers through higher prices.

Some might argue that tariffs encourage consumers to switch to domestic producers who don’t face the tariff. While this is true, that doesn’t mean there’s no cost to consumers because domestic producers likely can’t supply the good at the same price as foreign firms. Otherwise, there wouldn’t have been imports in the first place. That means prices will still go up, and consumers will still bear much of the tariff’s cost.

In short: When tariffs are raised, at least some and possibly all of the cost will fall on domestic consumers through higher final prices. Anyone who claims otherwise is being disingenuous.

A natural follow-up people might have is, “Well, maybe prices for consumers go up, but it could be worth it to help domestic industry.” I’ll cover that in my next post, but the preview of the answer is “no”.

Originally published at https://mytwocentsandcounting.substack.com.