Could US Buyers Bear the Cost of Import Tariffs?
By Ian Sheldon (sheldon.1@osu.edu)
To trade economists this seems a rather odd question, the answer to which would be: well of course tariffs impose costs on buyers (consumers and firms purchasing inputs), and the basic explanation can be found in any undergraduate international economics textbook.
US supply and demand conditions for a single good are shown in the figure, where in the absence of a tariff, US buyers purchase Q4 of the good, paying the world price, while US firms produce Q1 at the world price, the difference between Q4 and Q1 being imports. If a tariff t is imposed, the US price of the imported good rises once it leaves the point of entry. Faced with a higher price, US buyers demand less of the good at Q3, while US-based firms supply more of the good at Q2, the level of imports falling to the difference between Q3 and Q2.
Given the increase in US prices, the loss to buyers is the area a+b+c+d, which can be divided into “transfers” and “inefficiencies”. Area a is the transfer from US buyers to US-based firms, who now receive a higher price, while area c is the transfer from US buyers to the US government in the form of tariff revenue. Areas b and d are losses, the former being due to inefficient expansion of US production, the latter being due to some buyers dropping out of the market, and those continuing to buy having to pay a higher price in the US.
The key difference between a tariff and a consumption tax is that while both see buyers paying a higher price for the good, a tariff results in inefficient domestic production. In principle, this inefficiency might be partially or even totally offset if the world price of the imported good falls, i.e., given the size of the United States, any reduction in its imports could result in exporters being forced to cut their prices, what economists call a terms-of-trade effect. However, many published studies have shown US buyers bore the full cost of higher tariffs levied on Chinese imports during the 2018-19 trade war (Fjagelbaum and Khandelwal, Annual Review of Economics, 2022). For example, one study found the price of washing machines increased by $90 (12 percent) after tariffs were imposed in early-2018 (Flaaen et al., American Economic Review, 2020).
In light of the announcement by the administration that all US imports from China will be subject to a 10 percent tariff, and that imports from Canada and Mexico could be subject to 25 percent tariffs, (New York Times, January 31, 2025) there is clear potential for a significant increase in the costs borne by US buyers.
A recent study presents updated estimates of the cost of the 2018-19 tariffs, along with estimates of what the costs of any new tariff increases might be (Clausing and Lovely, PIIE Policy Brief, 24-1, May 2024). Bottom-line: the US-China trade war resulted in costs to US buyers equivalent to 0.4 percent of US gross domestic product (GDP), and if all tariffs that have been mooted by the President are eventually put in place, the cost to US buyers could rise by up to 1.8 percent of US GDP, i.e., $500 billion a year.
(This is a revised version of an earlier blog on this topic)
