The Trump administration recently floated a plan for a twenty percent tariff (or tax) on goods imported from Mexico to pay for the southern border wall. During the campaign, Mr. Trump promised to both build the wall and make Mexico pay for it. Does taxing imports from Mexico ensure this?
The answer depends on the economics of taxation known as tax incidence. Economics allows us to assess who really pays a tax, and one important result shows that the person who must send the payment to the government is not who really pays. So a tariff on imports from Mexico will not necessarily make Mexico pay for the border wall.
I will only focus today on who pays the tariff. I will not address other questions about the proposal: Is a border wall a good idea, or going to effectively stem illegal immigration? Is a tariff on imports from Mexico good policy, or even legal given our nation’s trade agreements? And, would the tariff produce enough revenue to cover the wall’s construction costs?
International trade involves foreign currencies and the balance of payments, which seem really complicated. A more familiar case like a gas tax can illustrate most of the economics. Suppose we imposed a $1 per gallon gas tax and used the revenue to clean up the environment. Could we validly say that oil companies were paying for the cleanup?
As drivers, we might suspect that the oil companies would just pass the tax on in the form of higher prices. This reaction is correct. Incidence depends on how much the price at the pump rises in response to the tax. Drivers fully pay the tax if the price rises by a full $1, while oil companies pay the tax if the price remains unchanged.
Oil companies will sell less gas than before, possibly a lot less, if they try to pass the entire tax on to consumers. As anything becomes more expensive, people will buy less of it; this is the law of demand. The price of gas generally will usually rise some, but less than the full $1.
Two factors determine the price rise: how much less gas drivers use as the price rises, and the willingness of oil companies to accept a lower price (net of the tax) to avoid selling less gas. These factors are called the elasticities of demand and supply. What does not matter is who the law makes send the tax revenue to the government.
Politicians like to leverage the mistaken beliefs about who pays taxes. For example, Social Security and Medicare payroll taxes are legally split between employers and workers. Equal cost sharing is a legal fiction, as elasticities determine the distribution of the burden of the payroll tax.
Tariffs on Mexico differ from a gas tax because not all suppliers of these goods will be taxed. Companies in the U.S. producing goods in competition with imports from Mexico will not be taxed, nor will imports from Europe or Asia. The supply of untaxed goods from the U.S., Europe and Asia will limit price increase, and thus whether American consumers or Mexican firms really pay the tariff.
But even saying that “Mexico” pays the tariff is highly misleading. Mexico is a nation of 130 million people, with thousands of firms exporting to the U.S. Some of these firms are owned by American or European or Asian companies, and many Americans invest in the Mexican companies. The economic burden of taxes does not fall on firms or nations but ultimately on workers and investors. The shorthand that “Mexico” pays some of the tariff is literal nonsense; only real persons pay taxes, including in this case some Americans.
The border wall may or may not be a good idea. But taxing goods imported from Mexico does not guarantee that Mexican citizens will pay for the wall. Supply and demand ultimately determine who pays taxes, not politicians’ pronouncements. Politicians frequently exploit confusion over complicated economic questions to make government projects appear better than they are in reality. Eventually, however, reality prevails.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.