President Trump’s insistence that Mexico will pay for a border wall piques much interest. The issue is more politics and emotion than finance. However, the economics underlying the question apply to several policies advocated by the new administration, so let’s explore.
The core issue is what we mean by “paying.” Trump has waffled away from his campaign stance implying that the Mexican government would remit money directly to the U.S. Treasury. Mexico may not do that, he says, but it will bear the cost some other way.
The most likely alternative seems to be that exports from Mexico will be subject to tariffs on entering the United States. But who, in that case, really bears the end burden? To economists, this is the “incidence” of a tax. Whose income or wealth is reduced by how much by the tax?
To most people, it seems clear that they pay the individual income tax because they or their employers remit money to the IRS. Similarly, most people are convinced that they bear the burden of gasoline and general sales taxes even though, in these cases, they do not make out a check to their state’s government.
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Despite the fact that gas taxes are not itemized, but rather are part of the pump price, and that it is the retailer that remits money to the state, consumers believe they pay the tax.
An import tariff, as Trump’s campaign proposed, is little different from a sales tax. It is a percentage of a good’s value, only it is imposed at the national border rather than at retail. The check to the government is written by the importer in the U.S rather than by a Chinese or Mexican exporter. So why do many people believe that “the Mexicans” or “the Chinese” would be paying such a tax rather than U.S. consumers?
This returns us to the meaning of “paying.” People are correct that the incidence of the personal income tax is overwhelmingly on the individual.
Gas and sales taxes are different. True, most of these are passed on to the consumer, but not exactly all. Some of the tax actually is borne by businesses all along the chain from producer to checkout.
The reason suppliers are affected is that a tax increases the price. At a higher price, people buy smaller quantities, particularly if there are other goods not taxed. Shifts may be small, but consumers spend slightly less on taxed items and slightly more on untaxed items. And they can buy less in total goods with a given monthly budget when more goes to tax.
So, to the extent that volumes sold go down as a product is taxed, the producers and sellers both pay a fraction.
Often, these effects on sellers are not apparent. So consumers think they, themselves, pay the entire sales or excise tax. But historical cases show this isn’t true.
Years ago, Congress enacted an excise tax on yachts. Supporters argued that only rich buyers would be affected. But building high-end boats is very labor intensive. Builders saw sales plummet. Hundreds of skilled workers were laid off. Everyone along the line ended up paying part of the tax.
A key variable is the degree to which the item taxed is a luxury or a necessity. With a real necessity, like salt or commuting gasoline, a price increase cuts quantity very little. Consumers bear virtually all the tax. But for yachts and other less-necessary items, the consumer bears less and producers or sellers more.
Let’s go back to import taxes. Apply one, and the immediate result will be these imported goods will cost consumers more. Slap a 35 percent tariff on avocados, cars and other Mexico-produced items, and households will have to pay more for them. But the price won’t necessarily go up 35 percent. It will depend on how “necessary” these items are. That depends on substitutes available.
If you can buy U.S.-origin cars or strawberries at only 5 percent more, then consumer prices will rise little. Economic adjustments will, indeed, largely be in Mexico. Sales, profits and employment of Mexican producers will all drop.
U.S. tariff revenues for the U.S. government will be minimal. Mexican firms will suffer greater drops in sales and income than those in the U.S.
Donald Trump and his supporters believe that there will be good domestic substitutes for things currently imported and there will be little effect on consumers.
Economists like me, who are skeptical, think that production will move back to the U.S. only if these products then cost substantially more. It will take a long time for these goods to come back into production here. Thus there will be increases in consumer prices, and for some items these will be large.
If the first view holds, then “the Mexicans” will “pay” for the wall. If the second, then U.S. consumers will “pay.” Note the total that actually flows to our Treasury varies directly with the amounts still imported after the tax is imposed. The more money to the Treasury, the more must come from U.S. households. The more borne by Mexicans, the less cash to the Treasury.
There will be winners. U.S. producers who cannot compete now will sell more once the tariff is applied. But U.S. firms now producing for export to Mexico will cut back output and employment.
Obviously there are myriad ramifications to what some see as a very simple question. But the short answer is indeed simple: A tariff on imports from Mexico will raise the cost of household purchases here. How much is an open question, as are all the other collateral effects.
St. Paul economist and writer Edward Lotterman can be reached at firstname.lastname@example.org.