A major assertion by the Trump Administration is that tariffs are paid for by foreigners. And, indeed, under very specific circumstances, a tariff may be paid in part or in whole by a foreign producer:
- if the importing country is a monopsony (or has significant market power),
- if the exporting country has price power, and
- if there is no foreign retaliation,
then a sufficiently small tariff could induce the exporting country to lower prices in order to retain market share. That is, the exporter may absorb some or all of the tariff (an interesting and non-technical discussion on the theory and its history can be found here).
At least on paper, the US seems to fit the description. We are one of the largest countries in international trade. US imports account for about 13.8% of global imports and exports are about 8% of global exports (data from the World Bank). Furthermore, in some individual markets, we are the largest buyers/sellers by far.
So, at least in theory, there should be some part of a US tariff that is eaten by the foreign producer. At yet, that is not the case in reality.
Indeed, tariffs imposed by the US government are pretty much entirely paid by Americans. Why is this the case? One could be tempted to throw away trade models and make unscientific appeals to things like greed or politics (as the White House has done). But one shouldn’t throw out a perfectly good theory except when it cannot explain things. And, as it happens, properly understood trade theory explains this seeming contradiction.
Most trade models treat countries as individual economic actors: The United States trades with Mexico. This is done for pedagogical purposes to help our students see that there is little difference between domestic and international trade. And there are times when treating countries as individual economic actors is useful or appropriate. The theoretical ability to pass on a tariff depends on treating countries as individual actors.
But the reality is that trade, all trade, ultimately occurs between individuals, not countries. The United States is not trading with Mexico. A firm in Dallas is trading with a firm in Mexico City. Consequently, while countries in the aggregate may have some sort of market power, individuals mostly do not. The actual ability to pass on a tariff, or to force a foreign supplier to pay a tariff, is limited to non-existent.
But isn’t this the point of tariffs? To “collectively” negotiate for all? Can’t we apply the same logic here to the “firm” called The United States? Alas, no. A country is not a firm. Short of outright socialism, the president is not negotiating for inputs for American firms. The firms are still the ones making buying decisions. It is their ability to pass on prices, not some fiction called “The United States Company,” that matters.
The predictions and proclamations made by the Trump Administration and its economists fail to come true because they do not appreciate methodological individualism: that economic decisions are ultimately made by individuals, and that must be where our analysis begins. Those who claim American market power can make foreigners eat the cost of US tariffs zoom out too far to the aggregate and forget that the aggregate is not independent, but rather emergent, from individuals.
This fatal conceit, this fatal error, has been the burr under the saddle of many a politician, and the Trump Administration is no different. Reality is not optional, no matter how many fancy Greek letters you have to say otherwise.
Update: Co-blogger David Henderson rightfully highlights what I should have made more explicit in this post, namely that elasticities matter. Allow me to retroactively make my implicit argument explicit.
Who actually bears the burden of a tax depends on relative elasticities. The more relatively inelastic the demand/supply curve, the more of the tax burden the individual will bear. What matters is not a country’s elasticity but the individual firms’.
READER COMMENTS
David Seltzer
May 29 2025 at 2:05pm
Jon wrote To “collectively” negotiate for all? Collectively negotiating for all means reduction in consumer and producer surplus. DWL. I suspect fatal conceits of both administrations has resulted in budget deficits, national debt, as a multiple of NGDP, and unfunded promises of Social Security and Medicare. The actuaries of these programs estimate that unfunded benefits in present value terms are about $80 trillion. Promised future benefits less projected program incomes. Q&D arithmetic. Ten years hence, the liabilities grow by 2.5% per annum. FV is $102 trillion. Current GDP is $30 trillion. For the economy to reach $102 trillion in ten years, it would have to grow at 13% compounded for ten years. Not likely. 30(1.13)^10 = 102.
Jon Murphy
May 29 2025 at 3:11pm
A technical point here:
Tariffs raise the price consumers pay for the good in question. Since the higher price leads to lower quantity exchanged in the market, consumer surplus goes down.
Some of that surplus is transfered to the protected producers. They see their producer surplus rise.
Some of that surplus is transfered to the government as tax revenue.
But consumer surplus drops by more than producer suplus + government surplus increases.
It is the difference between the gains to the producers/government and the loss to consumers that is the deadweight loss.
David Seltzer
May 29 2025 at 3:30pm
Thanks Jon. I hadn’t considered protected producers. Question: How long does their surplus last? If they are protected, that means the tariffs have been implemented against foreign producers who had a comparative advantage. Now the protected supplier sells a poorer product. Wouldn’t demand for that product shift down and to the left with less quantity demand at each price, ceteris paribus?
Jon Murphy
May 29 2025 at 3:32pm
Over time, it is possible (maybe even probable) that people move away from the product, causing demand to fall. But how long that takes is anyone’s guess
Warren Platts
May 31 2025 at 1:47pm
Isn’t the fundamental assumption of methodological individualism is that individuals are rational profit-maximizers? Therefore, why assume that foreign producers almost always pass on the tariff to American consumers? Under free market conditions where there’s lots of suppliers and lots of buyers, there will be an equilibrium, market-clearing price. If a tariff is then introduced, the tax burden will depend on the supply & demand elasticities. The only way you can get 100% passthrough of a tariff to consumers is if the foreign supply is perfectly elastic or if the home demand is perfectly inelastic.
To take a simple example, we draw a supply & demand chart where the supply curve is P = Q and the demand curve is P = 200 – Q. The market clearing price is $100 and quantity supplied is also 100. Now introduce a 20% tariff. Since the absolute value of both slopes is the same, the tax burden is shared equally. Thus the producer price is $90.91 and the consumer price is $109.09 — only a 9% consumer increase on a 20% tariff.
That’s the math. But what about from an individual perspective? If I’m importing strawberries from Mexico, I can’t force my old supplier to eat the entire cost of the tariff, but if he doesn’t absorb at least part of it, I will call around and find a supplier who will. Thus all individual firms will have to go with the flow if they want to stay in business.
Now suppose all suppliers are consolidated into a single firm because the anti-trust regulators on duty are asleep. The individual, since he’s a profit maximizer will no longer follow the free market pattern. Let’s assume his unit cost of goods $60, so he’s making a 40% gross margin at the former free trade price. He can goose his gross margin to 53.85% and maximize his profits by reducing sales by 30% to 70, while increasing his price by 30% to $130.
Now what happens if Trump imposes a 20% tariff? The supplier has the market cornered; he could pass the cost of the entire tariff on to consumers. But will he? Not if he’s a profit maximizer. His best bet is to reduce his price to $113, thus the consumer price will be $136 (Q=64) and after paying the tariff, he’ll have a profit of $3,413 that is more than the $3,080 he would have got if he had forced his buyers to eat the entire cost of the tariff at his old price of $130.
But what if the individual firm is a Chinese firm. Then all bets are off because all Chinese firms take their instructions from the CCP. Even if their are a bunch of firms, the CCP can form a cartel out of them, and so the only individual making decisions ultimately is the Chairman of the party.
Since theses individuals are Communists, they are not profit maximizers, nor are they constrained by markets; rather their goal is meet production targets mandated by the government. So suppose our individual Chinese firm is happily getting monopoly prices by producing only 70 units, but then gets a call from the politburo to double exports to 140 because of the real estate collapse. Well, what happens is the firm doubles exports to 140. Of course to get American consumers to buy that much more, they have to slash prices down to $60, and since the COG is $60, they are making zero profit. But the CEO doesn’t care; at least he’s breaking even.
Then individual Trump gets mad at the Chinese dumping and imposes a 20% tariff. So now how does the individual Chinese CEO respond? Well, he’s still got his production quota of 140, so he has to slash his prices even more to $50 so that the $10 unit tariff yields the consumer price of $60. Of course, now the Chinese firm is seriously in the red with a loss of $1,400; but again, that doesn’t matter because the Chinese government will make up the difference through a subsidy.
Now, who is *really* paying the tariff in this case? China? Not really. The CCP in their wisdom decided that the geopolitical gains resulting from the overproduction are worth the cost of the subsidy. Thus it’s actually U.S. producers that pay for the tariff through lost income. That is, the Chinese industrial policy set by individual CCP technocrats dictates the U.S. industrial policy that results in a transfer from individuals involved in the U.S. manufacturing sector to individual U.S. consumers not involved in manufacturing.
Janet Bufton
Jun 1 2025 at 12:27pm
No. There’s no fundamental assumption, it’s just the name for an approach in which choices are understood as being made at the level of the individual and guided by that individual’s goals, the incentives they face, and the constraints they’re subject to. This also applies to individuals who make decisions in and through groups.
Jon Murphy
Jun 2 2025 at 7:14am
Janet is right. Methodological individualism just means that the individual is the focus of analysis. They may be profit maximizers, they may be utility maximizers, they may be “pain reducers,” etc. All sorts of assumptions exist. They may be rational, they may be boundedly rational, they may be “predictably irrational,” etc. All sorts of assumptions exist.
And yes, elasticity determines ultimately who bares the burden of the tax (see my update at the bottom).
Methodological individualism helps us determine the relevent elasticities to determining who bears the burden of a tax.
Jose Pablo
Jun 2 2025 at 5:24pm
Instead of resisting it, you should embrace Jon’s invitation to apply methodological individualism, along with his frequent advice to “think at the margin” (the two are closely related, after all), to make arguments favorable to your thesis.
Since you’re constructing the supply curve from scratch, let’s suppose that the marginal strawberry producer is domestic, with a marginal cost of $100 per unit
[You’re implicitly assuming strawberries are a commodity, so if $100 is the market-clearing price, this would technically be the marginal cost of the first producer left out of the market, but let’s keep things simple].
Now imagine that the lowest-cost foreign producer has a marginal cost of $80.
In that case, a 20% tariff would:
a) have no effect on aggregate demand,
b) have no effect on market prices, and
c) be fully absorbed by the foreign producers.
The policy implication is clear: you want to target industries where the marginal producer is domestic and there’s a meaningful cost gap with the first foreign importer (or, alternatively, you want to tailor the tariff to the cost gap of each industry).
Of course, there’s no free lunch. In such industries, it’s quite likely that foreign producers were on the verge of expanding capacity, which means Americans will miss out on future price declines. Over time, this would have likely forced the exit of the domestic marginal producer and enabled the positive, growth-enhancing reallocation of resources toward more productive uses (after all, the marginal producer is defined by having zero or even negative return on the capital employed). But if you’re comfortable with those tradeoffs, your logic holds.
Granted, the picture is more complex; widespread tariffs would modify the demand curve elasticity (you will require general equilibrium to define the new demand curve for strawberries), relative prices and dynamics in other international markets would also play a role …
Still, the core advice stands: embrace Jon’s methodological advice. It may do more to support your case politically than you seem to realize.
Jose Pablo
Jun 2 2025 at 6:02pm
you want to target industries where the marginal producer is domestic and there’s a meaningful cost gap with the first foreign importer
At least if your goal is to have foreigners pay the tax, turning the tariff system into an External Revenue Service. But this would do nothing to reduce the deficit, and punishing “unfair” countries would, at best, be a byproduct of the policy, not a guiding principle.
You can not have it all.