Krugman: Who would pay for tariffs? Consumers, of course

By Paul Krugman / The New York Times

Imagine yourself as a small-business owner who produces something — say, plastic lawn ornaments — for American consumers. (One of my uncles actually was in that business.) Then for some reason, politicians propose imposing a tax of 25 percent or more on all sales of pink flamingos, garden gnomes, etc.

What will you do if that tax comes into effect? Will you pass the tax increase on to your customers, or will you try to keep consumer prices unchanged and absorb the tax yourself?

Well, you’ll certainly tell politicians that your customers will end up paying, and you’ll probably be telling the truth. Your costs, in effect, will increase, and your profit margin probably isn’t high enough to absorb the tax, even if you wanted to.

Now change the story a bit: You’re not an American small-business owner; you’re a Chinese company selling stuff to the United States; and the tax in question is a tariff, a charge levied on goods imported from China. Why should the answer be any different? Normally, we’d expect the tariff to be passed on to U.S. consumers.

Donald Trump, however, loves tariffs and insists that they are paid by foreigners. So leading Republicans, who increasingly seem to be using George Orwell’s “1984” as an instruction manual — whatever the leader says is true — have taken to claiming that tariffs (and only tariffs) are a tax on business that doesn’t hurt consumers. “The notion that tariffs are a tax on U.S. consumers is a lie pushed by outsourcers and the Chinese Communist Party,” a spokesperson for the Republican National Committee recently declared.

But how do we know that consumers really do pay for tariffs? I just tried to convince you with a thought experiment; I could also point to the fact that a vast majority of economists believe that tariffs are primarily paid by consumers. But not everyone finds thought experiments persuasive, and many people distrust economists. So can I offer any more direct evidence?

Why, yes, I can, thanks to a guy named Donald Trump, who imposed some high tariffs on China in 2018 and 2019, giving us an opportunity to see what happened to prices; basically what economists would call a natural experiment. There have been some careful statistical analyses of the effects of the Trump tariffs. But I thought it might also be helpful to offer a quick and dirty overview.

Chad Bown of the Peterson Institute for International Economics (now the chief economist of the State Department), examined the recent history of U.S. tariffs on Chinese goods and vice versa. The average U.S. tariff on imports from China rose in 2018 and ’19 to about 21 percent, from about 3 percent, an increase of 18 percentage points. The only way that could not have raised prices for U.S. consumers would have been for Chinese companies to have cut their U.S. prices by a similar amount. But they didn’t: The average price of imports from China fell only around 2 percent, and even that small decline might have been a continuation of a long-term trend of falling Chinese export prices.

So we have an 18-point rise in tariffs offset by only a 2 percent decline in Chinese prices net of tariffs. That sure looks as if American consumers bore the great bulk of the burden.

OK, in fairness, I should mention a caveat to this conclusion. The United States is a big country, sufficiently so that if it imposes tariffs on a broad range of goods, it can improve its terms of trade, the prices of its exports relative to its imports; that is, if other countries don’t respond with tariffs on U.S. exports. (This goes under the unhelpful name of optimum tariff theory.) In practice, this would work via a rise in the value of the dollar if the U.S. reduced imports, which would lower the dollar prices of the goods we still import. And this effect wouldn’t be confined to the prices of imports from the countries subject to high tariffs: A tariff on Chinese goods could end up reducing the prices of goods we buy from, say, Germany.

But it’s a moot point because if America imposed widespread tariffs, other countries would do the same, partly as retaliation, partly just as emulation. So consumers would pay the tariffs after all.

Which consumers? Bear in mind that Trump’s economic program calls for a combination of tax hikes in the form of higher tariffs and tax cuts for corporations and high-income individuals. He has even floated the idea of replacing the income tax with tariffs, which almost certainly isn’t feasible, but we can ask what would happen if he collected as much tariff revenue as possible while cutting income taxes by the same amount.

According to Kimberly Clausing and Maurice Obstfeld of the Peterson Institute, this is how that combination would affect Americans at different income levels: The net effect would be negative for 80 percent of the population, especially for the bottom 60 percent, while extremely positive for the top 1 percent.

There are two reasons for this regressive outcome. First, lower-income families spend a higher share of their income than the rich, so they would be hurt more by what would amount to a large sales tax. Second, income taxes are disproportionately paid by the affluent — around half the population doesn’t pay income taxes at all, although they pay lots in other taxes, such as the payroll tax — so the benefits of cutting that tax would flow mainly to the top.

So who would pay the tariffs that Trump will almost surely impose if he wins? Not China or foreigners in general. Everything says that the burden would fall on Americans, mainly the working class and the poor.

This article originally appeared in The New York Times.