Who really pays in Trump’s border wall plan

President Trump’s insistence that Mexico will pay for a border wall has piqued much interest in emails I’ve received from readers.

The issue is as much political and emotional as it is economic. However, the underlying economics applies to a wide range of trade issues promising to be at the center of this administration. Thus, understanding it is fruitful beyond the immediate issue of who will pay to build and maintain a physical wall, 50 feet high and 2,000 miles long.

Let’s start with some examination of what we mean by “paying.” Trump acknowledges it’s more complicated than a check from the Mexican government to the U.S. Treasury. Mexico may not do that, he says, but it will bear the cost in some other way. It may be that exporters from Mexico will pay tariffs on shipments to our country. But who, in that case, will really bear the end burden?

This issue parallels the larger economic question of who really “pays” any tax. It is more complicated than who exactly signs a check to some government.

To most people, it is clear that they pay the individual income tax because they themselves remit money to the Treasury or it is deducted from their pay and sent by their employer. Ditto for the individual worker’s half of the FICA imposed for Social Security and Medicare.
Think about the other half of FICA, however; the employer’s contribution. Does it all come from the employer? It isn’t as clear as you might think. Neither is the issue of who pays taxes on goods traded across borders.

Most people hold pretty firm ideas about who pays domestic taxes on goods. Consumers don’t write out checks to the state for gas taxes. These aren’t even itemized. But people know the money is coming from their wallet. Sales taxes on other items are itemized and people similarly believe the money comes out of their pockets.

An import tariff as proposed by Trump in his campaign, particularly on imports from Mexico and China, is little different from a sales tax. It is a percentage of the value of a good, in this case at the national border instead of at the retailer. The check to the government is written by the importer — here in the U.S. — rather than the merchant in China or Mexico. So why do many people believe that “the Mexicans” or “the Chinese” will be paying such a tax rather than, in the end, the consumers who buy the merchandise?

This brings us back to what we mean by “paying.” To economists, this issue is called the “incidence” of a tax. Whose income or net worth ultimately is reduced by how much as a result of imposing the tax?

As noted, people are correct that the incidence of the personal income tax is overwhelmingly on the person paying. And, as a tax specific to labor income, the employee effectively pays most of both halves of FICA even though it is nominally split. Yet the employer also picks up some fraction of both halves.

Ditto for the motor fuel tax. Yes, most of it is passed on to the consumer, but not exactly all.

As for sales taxes, consumers don’t always pay all. But how can this be if the tax is listed right on the cash register slip? To answer, one must measure everyone’s income and net worth with and without the tax. This would include the original manufacturers of goods, wholesalers, retailers and buyers. How much money do they have with or without the tax?

For sales and excise taxes, most is paid by the consumer, but some by businesses all along the chain from raw material to product at the checkout.

The reason suppliers in Mexico and China are affected is that imposing a tax increases the price. At a higher price, people buy smaller quantities, particularly if there are other goods and services not hit by the tax. 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 some goes to tax.

So, to the extent that the volume of business goes down because a product is taxed, the producers and sellers of the item pay a fraction of a tax.

In most cases, these effects on sellers are not apparent. So consumers understandably may assume that they, themselves, pay the entire amount of sales and excise taxes. But occasional cases show this isn’t true.

Years ago, Congress enacted a special excise tax on luxury autos and yachts. Supporters argued that only fat cat buyers of these goods would be affected. But building high end boats is very labor intensive. Yacht builders saw precipitous drops in sales and hundreds of skilled workers were laid off. Everyone along the line ended up paying part of the tax.

A key variable here is the degree to which the item taxed is a luxury or a necessity. In a real necessity, like salt or gasoline, a price hike will cut quantity sold very little and the consumer bears virtually all of the tax. But for high-end boats and other less-necessary items, the consumer bears less and someone along the supply chain bears more.

This returns us to import taxes. Apply one and the immediate result will be these imported goods will cost more to households. Slap a 35 percent tariff on avocados, strawberries, Fords, Audis and other items produced in Mexico 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 in part on the substitutes available.

If you can buy a U.S.-made car or U.S.-grown strawberries at only 5 percent more than the pre-tariff price of the Mexican-produced items, then consumer prices will go up little when the tariff is instituted. The economic adjustment will, indeed, largely be in Mexico. Sales, profits and employment of Mexican producer firms will all drop.

Tariff revenues for the U.S. government will be minimal since the quantity covered will be small. Mexico won’t pay in the sense of money from that country flowing into U.S. Treasury coffers. But businesses and individuals in that country will suffer greater drops in sales and income than those in the U.S., at least to the degree that these businesses are not U.S. owned.

That obviously is not true for Ford or any of the myriad other facilities in Mexico owned by U.S.-based corporations. To the extent that border taxes cut quantities imported, tens of billions of dollars of U.S. investment in Mexico will become non-paying white elephants.

Donald Trump, and the millions of people who like his proposal, believe that there will be good domestic substitutes for things currently imported.

They believe there will be little effect on consumers. People like me, and most other economists, who are skeptical, think that if production moves back to the U.S., these products will then cost substantially more. It also will take a long time for some of 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” indeed will see their incomes or net worth drop and will, in that sense, “pay” for the wall or other new policies involving raised tariffs. If the second occurs, then it is U.S. consumers who will “pay.” Note that the amount of money that actually flows to the U.S. Treasury varies directly with the amounts still imported after the tax is imposed. The more money to the Treasury, the more must come out of the pockets of U.S. households. The more born by Mexicans, the less cash to the Treasury.

There will be winners. U.S. producers who currently cannot compete with low-cost Mexican products will sell more once the tariff is applied. Ford will bring certain auto production for the U.S. market back home, but use their Mexican facilities for sales in that country and in some other countries. They and other firms that increase U.S.-based production will hire more people. They will buy more raw materials, perhaps also provided by U.S. producers. But some of the many U.S. firms now producing for export to Mexico will cut back output and employment.

Note also that if the tax applies only to imports from Mexico, but not to the same items from any other country, then there will be plenty of good substitutes. U.S. consumers will pay little more. Asparagus producers in Mexico will suffer and those in Peru will gain. Audi’s Mexican plant will lose profitability but its facilities back in Germany will produce more. So a tax applied only to imports from Mexico so as to raise money to pay for a wall won’t raise much money and won’t favor U.S. producers to any great extent.

For economists, there are broader issues of what the total gains and losses are to everyone concerned, producers and consumers alike, either in our country or globally.

There also is the question of how Mexico will react. If we tax Mexican-produced avocados and cars, will they tax U.S.-produced corn and heart valves?

Obviously there are myriad ramifications to what some see as a very simple question. But the short answer is that 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.