US president Donald Trump suggested on Thursday that he would consider using a 20% tax on imports from Mexico in order to generate funds to build a wall. To Trump’s supporters, this plan may sound great: Mexico’s exports will be taxed! They’ll pay for the wall in the end! And it’s true that this really would disadvantage Mexico relative to the US, which could be good for some American manufacturing jobs.
But there is a big drawback—which may explain why his staff is now backpedaling. This tax would mostly be paid by US consumers, in the form of higher prices. How do I know? Basic economics.
Here’s a simpler example. Imagine the government imposes a $1 tax on each gallon of gasoline. And let’s say the way they implement that tax is by requiring oil companies to pay them a bunch of money at the end of the year—specifically, $1 for each gallon of gas they sold. Sounds like a tax on the oil companies, right?
Not so fast. When the price of oil rises, gas companies make up for a lot of their losses by charging consumers more. They do the same with a tax increase. Even though the payment seems like it comes from the gas company, it really comes mostly out of consumers’ pockets.
Economics has a tool to figure out just how much of that tax increase will be paid by consumers. It all depends on how easy it is for consumers to substitute something else for the object that’s being taxed. The easier it is to substitute, the less tax they pay. In the case of gas, it’s hard for consumers to substitute away, and they end up paying most of the tax.
So how does this relate to Mexico? In this case, the suppliers are the ones who should have an easy time finding a substitute for American purchasers. Mexican companies will likely to be able to shift their sales elsewhere. (China will love avocados!)
But since people in the US buy a lot of products from Mexico, there are not such easy swaps. So the prices to the consumer will go up, potentially by almost the entire tax.
The only thing that would be worse is a tariff on all imports.