On Wednesday, President Trump either did or didn't suggest that Mexico will pay for the construction of a border wall between the U.S. and Mexico through a 20% import tax on all goods imported from Mexico. Here's how the NYTimes reports it:
President Trump’s decision to build a wall along the length of the United States’ southern border with Mexico erupted into a diplomatic standoff on Thursday, leading to the cancellation of a White House visit by Mexico’s president and sharply rising tensions over who would pay for the wall.
With the conflict escalating, Mr. Trump appeared to embrace a proposal by House Republicans that would impose a 20 percent tax on all imported goods. The White House press secretary, Sean Spicer, told reporters that the proceeds would be used to pay for the border wall, estimated to cost as much as $20 billion.
The White House has backed off the claims a little bit, so it's not clear whether the import tax is a solution, a proposal, a suggestion, a trial balloon or something else...but, regardless of the politics, it can still be used as a teaching point: Who would really pay for the wall if a 20% tax were levied on all imports from Mexico?
The simple logic of the import tax goes something like this: Every time Mexico wants to sell something in the United States, Mexico will have to pay 20% of the proceeds to the U.S. government. The revenues collected from Mexico will be used to pay for the construction of the wall. Therefore, Mexico is paying for the wall.
But does that logic hold up to economic analysis? Let's take a look at a series of pictures.
First, here is the market for a hypothetical Mexican good we'll call TortiXXa (click to make it bigger). It's a beer (why not?)*.
The blue line represents the demand for TortiXXa in the U.S.. It slopes downward to represent the fact that at lower prices U.S. consumers was to buy more TortiXXa--that's the law of demand.
Where demand and supply cross is the market price for TortiXXa in the U.S..
So what happens when an import tax is levied on TortiXXa? The first thing the producers will try to do is pass the tax on to the consumer (if you were a producer, wouldn't you?). So the tax has the effect of rotating the supply curve upward from it's original position (if there were no reaction on the demand side, the price for a TortiXXa beer is now 20% higher). Here's a picture:
The red line is the new supply of ToriXXa after the tax. The new price for TortiXXa is now higher (where the red supply crosses the blue demand). As a result of the import tax, the price to U.S. consumers goes up, but it doesn't go up by the full 20% because consumers buy less at higher prices--again the law of demand. To counter this, teh producers (Mexico) are willing to absorb part of the price increase due to the tax.
So it looks like U.S. consumers are paying higher prices for TortiXXa. Doesn't that mean that U.S. consumers are really paying the tax?
The price after the tax is what U.S. consumers have to pay for TortiXXa after the Mexican producers try to pass the tax on to U.S. consumers. To figure out who is really paying the tax, we have to subtract the tax from the price (the producer of TortiXXa collects the price from U.S. producers and then pays the tax to the U.S. government). Remembering that we drew the red supply curve by just adding the 20% tax to the prices from the black supply curve, the amount of the tax is the distance between the supply curve with the tax, and the supply curve without the tax.
- The price U.S. consumers pay after the tax (where the red and blue lines cross) is higher than what they were paying before (where the black and blue lines cross).
- The price the TortiXXa manufacturers get after the tax is subtracted (the point on the black line directly below where the red and blue lines cross) is lower than what they were receiving before the tax (where the blue and black line cross).
- The difference between the price that U.S. consumers pay after the tax, and the price TortiXXa manufacturers receive after they have paid the tax represents tax revenue to the U.S. government.
So what does all of this mean? It means that part of the tax is paid by U.S. consumers (the difference between the price U.S. consumers paid before the tax, and the price they pay after the tax), and part of the tax is paid by the Mexican manufacturer of TortiXXa (the difference between the price they receive before the tax, and the price they receive after the tax is subtracted).
If we multiply the amount of the tax by the number of bottles of TortiXXa sold, we will be able to figure out the total revenue collected by the U.S. government from the import tax, and we will be able to figure out who pays for the wall. Here's the final picture:
The import tax results in U.S. consumers paying more for TortiXXa, some of which goes to the U.S. government (the green area), and the tax results in the Mexican TortiXXa producers receiving less revenue for the production of TortiXXa (the red area).
So to answer the question of who pays the 20% import tax, the answer is that both U.S. consumers and the producers of TortiXXa pay the tax.
I will leave it to you to decide whether that means Mexico paid for the wall.
*This analysis holds for ANY good imported from Mexico. I just like beer.