Tariffs- Economic incidence
With the election of Donald Trump, there has been much discussion about his platform, particularly his plan for across-the-board tariffs. Political opinions aside, I want to take a moment to discuss tariffs- what they are, what they try to do, and what one might see when they are enacted.
What are tariffs?
Tariffs are essentially taxes that a government places on imported goods. These taxes serve various purposes: encouraging domestic production, reducing foreign competition, or addressing trade deficits.
Who pays tariffs? Statutory vs. Economic incidence
Here’s where it gets interesting. While importers are legally responsible for paying tariffs, the economic burden often shifts to others. Economists call this the difference between statutory incidence (who is legally required to pay) and economic incidence (who actually bears the cost).
Let’s say we run an importing business together- ReallyGood Imports. Every month, we bring in French cheese, paying $100 per wheel and selling it for $110. Now, a 20% tariff is imposed on imported goods. Suddenly, that cheese costs us $120 instead of $100. If we keep selling it at $110, we’d lose money. So what do we do? We raise the price to $130 to cover the extra cost. That $20 increase is an example of the economic incidence of the tariff. While we legally pay the tax, our customers share the burden through higher prices.
Price takers and price makers
Let’s revisit our business, ReallyGood Imports. As a small importer, we bring in 10 wheels of French cheese each month. After the 20% tariff, our price increase pushes 30% of our customers to find their cheese elsewhere. In response, we scale back—importing only 7 wheels next month.
For our small operation, this change barely registers with our French suppliers. They keep churning out cheese, blissfully unaware of our reduced order.
But what if ReallyGood Imports isn’t a small company? What if we import 10,000 wheels of cheese every month? We’ve still priced 30% of our customer base out of the market, and drop our imports to 7,000 wheels. This time, the impact is no longer just a drop in the ocean. French suppliers see their revenue plummet by $300,000, with 3,000 surplus wheels sitting in storage.
What do they do? They adjust. They lure us back. They lower the price of their cheese to $90 per wheel. Encouraged by the discount, we increase our imports slightly. Now every wheel costs us $90 plus an $18 tariff, totaling $108. We sell the cheese for $118.
Who wins and who loses?
Let’s break it down:
Our customers bear part of the cost, paying $8 more per wheel.
Our suppliers bear the rest, losing $10 per wheel due to the price drop.
The result? Both our customers and suppliers share the economic burden of the tariff, while the government collects their new tax revenue.
ReallyGood Imports’ profit margins slimmed, our customers had to pay more for their favorite cheese, and our suppliers had to decrease their price. But is there a way that ReallyGood Imports and our customers can come out ahead?
Let’s return to our scenario when we started importing only 7,000 wheels of cheese. Our suppliers reduce their price. This time, we decide that extra money would be better spent investing in a domestic cheese factory, but continue to import 7,000 wheels.
Another month goes by, and our suppliers now have 6,000 wheels of surplus cheese sitting idle. Desperate to offload their stock, they drop their price further- $75 per wheel. At that price, we can’t resist. We import the cheese, pay the $18 tariff, and sell it with our original 10% margin for $99 per wheel.
It looks like a win, right?
Our Company: We made $9 per wheel
Our Customers: They’re paying less—$99 instead of $110.
Aren’t you forgetting something? Our suppliers. ReallyGood Imports made $9, and our customers saved $11, but our suppliers lost $25.
Although simplified, this scenario demonstrates a very important aspect of tariffs- they rarely create a win-win scenario. When tariffs are levied, the domestic country cannot be made better off unless the foreign country is made worse off to a greater degree.
Dead Weight
That $5 imbalance we mentioned earlier doesn’t just vanish—it’s lost to the inefficiency of the market, a phenomenon economists call deadweight loss. Simply put, deadweight loss represents value that no one gets—neither consumers, producers, nor the government. It’s the economic equivalent of throwing money into the wind.
And economists? They have no patience for inefficiency.
It’s important to note that tariffs are not a tool for decreasing prices. Can they decrease prices? Depending on market share, yes. But this comes at the cost of global trade inefficiency, and being seen as a non-cooperative entity in the market. As globalization increases, the power to make yourself better off through tariffs diminishes more and more.
