A Bad Argument

for a mostly correct conclusion

Scott Bessent Finally Admits the Truth About Trump’s Tariff Costs

Trump’s treasury secretary knows exactly who’s paying for his sweeping tariffs.

Treasury Secretary Scott Bessent was finally able to admit that tariffs are indeed a tax on American importers and consumers, as Trump’s tariffs affecting virtually the entire world took effect on Thursday.

…

“But assuming it does come from Brazil, say, or it comes from any country with a tariff,” Robinson said, pulling him back to the actual question. “Who writes the check to the Treasury?”

“Well, the check is written to the person who receives it at the dock, in the U.S.”

“Mhm, the check, is, quote, ‘written by the person who receives it at the dock.’ So the tariff is paid in this country by the importer, is that right?” Robinson said, again highlighting the crux of the matter. (The New Republic, Breaking News)

The check is written by the importer but who writes the check does not tell us who bears the cost of a tax.¹ A tariff makes foreign goods more expensive to importers so they raise the price they charge. Part of the cost of the tax is being born by the importers, the people who write the check, as a reduction in their profit, part by their customers in higher prices.

The higher price of the imports reduces American consumption. If sales to Americans are a substantial part of world sales the decrease in American demand might lead to a reduction in the world price, in which case part of the cost of the tax is born by the foreign producers. The author of the New Republic article is reaching something close to a correct conclusion — most of the burden of most of the tariffs is born by Americans — but a conclusion that does not follow from the evidence he offers.

The mistake of assuming that the burden of a tax is born by whomever hands over the money is not limited to the case of tariffs. Consider the taxes that fund Social Security, half on the employer, half on the employee. Of each dollar the employer pays ten cents goes to the government, ninety to the employee, who pays ten cents to the government (rate invented to simplify the argument). It follows that of each dollar the employer pays the employee gets eighty cents, the government twenty.

What matters to the employer, in terms of his own welfare and his willingness to employ people, is what he pays. What matters to the employee, in terms of his own welfare and his willingness to take the job, is how much he gets. Whether the government takes the money before or after the transfer from employer to employee or, as in the present system, half before and half after, does not matter, is a purely cosmetic difference. The result would be the same if the tax was wholly on the employer, who would pay twenty cents of each dollar to the government and eighty cents (untaxed) to the employee. It would be the same if the tax was wholly on the employee, who would receive the full dollar paid by the employer, pay twenty cents to the government, end up with eighty cents of each dollar.

Corporate Tax

Corporations hand over the money. The corporation is a legal person but who bears the burden depends on how the tax affects actual persons, stockholders, employees, customers. If corporations paid corporate taxes by reducing the dividend paid to stockholders investing in corporate stocks or bonds would become less attractive relative to other things people could do with their money. The reduced supply of capital to corporations would raise the price they must pay to get it which raises the cost to them of producing things. They raise their prices, the amount they sell decreases. Producing less means employing fewer workers — corporate wages and employment decrease.

How the burden of the tax is divided among stockholders, workers, and customers depends on how sensitive each is to price paid or received. If demand is perfectly inelastic — customers buy the same amount whatever the price — the corporation can raise the price of its goods to cover the full amount of the tax, produce the same amount as before, hire the same number of workers, pay the same dividends; all of the burden falls on the customers. Other assumptions about demand and supply for goods, labor and capital give other distributions of burden.

The observation that who bears the cost of a tax is not determined by who hands over the money is not new; Adam Smith recognized it almost two hundred and fifty years ago as described in a previous post.

Naïve Price Theory

The author of the New Republic piece, someone who thinks the division of the Social Security tax between employer and employee matters, someone who believes that the burden of corporate tax is born by the corporation or its owners, are all making the same mistake:

All of these examples have one element in common. In each case, the mistake is in assuming that one part of a system will stay the same when another part is changed. … . I like to describe this mistake as naive price theory — the theory that the only thing determining tomorrow's price is today's price. Naive price theory is a perfectly natural way of dealing with prices — if you do not understand what determines them. … . In each case, a reader unfamiliar with economics might argue that since I said nothing about the price changing when the problem was stated, he assumed it stayed the same.

If that seems like a reasonable defense of naive price theory, consider the following analogy. I visit a friend whose month-old baby is sleeping in a small crib. I ask him whether he plans to buy a larger crib or a bed when the child gets older. He looks puzzled and asks me what is wrong with the crib the child is sleeping in now. I point out that when the child gets a little bigger, the crib will be too small for him. My friend replies that I had asked what he planned to do when the child got older — not bigger.

It makes very little sense to assume that as a baby grows older he remains the same size. It makes no more sense to assume that the market price of a good remains the same when you change its cost of production, its value to potential purchasers, or both. In each case, the assumption "If you did not say it was going to change, it probably stays the same" ceases to make sense once you understand the causal relations involved. That is what is wrong with naive price theory.

Why, you may ask, do I dignify this error by calling it a price theory? I do so in order to point out that in each of these cases, and many more, the alternative to correct economic theory is not doing without theory (sometimes referred to as just using common sense). The alternative to correct theory is incorrect theory. In order to analyze the effect … [of a change] you must, explicitly or implicitly, assume something about the effect on the price; you do not avoid doing so by assuming that there is no effect. (Price Theory, Chapter 2)²

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1. A point discussed in an earlier post in the context of other taxes.

2. The part of the chapter this is lifted from involves different examples of the same error. To find it search for the subhead “Four Wrong Answers.”