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What Econ 101 says about taxes (and tariffs)

The Star Tribune recently carried a very good article explaining, one, why taxes are often paid by people other than those who politicians claim will pay them, and, two, how this insight is selectively applied.

The column by Doug Tice, commentary editor at the Star Tribune, was titled ‘Econ 101 is politically conducive — suddenly, selectively‘. In it, Tice argued that tariffs are taxes, that the incidence of taxes, ie, who actually bears the burden of them, is decided by elasticities and not by political decree, and that “progressive America” “formerly seemed to have occasional difficulty grasping” this.

Tice is right on each of these. Taxes are tariffs. If you impose an excise tax of $3.04 on a pack of cigarettes, as Minnesota does, then for each pack of cigarettes sold, the seller has to send $3.04 to the state government. Likewise, when the President imposes a 25% tariff on Chinese steel, the American purchaser of steel from China has to send an amount equal to 25% of what they spent on steel to U.S. customs. The cigarette tax and the steel tariff work in pretty much the same way.

But, while the cigarette vendor and the steel importer might hand the money over to the state government or customs, that does not mean they actually bear the burden of the tax. This is where the concept of tax incidence comes in. Cigarettes are a good example. People find it hard to stop smoking, I know, I had to get hypnotized. So, the vendor can add $3.04 to the price of cigarettes and the smoker will more than likely pay it. In this case, demand is said to be ‘price inelastic’ and so the incidence of the tax falls on the smoker. The same goes for steel. If the importer sells their steel on they can add the 25% they had to send to customs to the price, if demand is price inelastic. If they use it to manufacture something, they can add that 25% to the price of the product, again, assuming demand is price inelastic. Evidence suggests that the burden of the current tariffs is being passed on to American businesses and consumers.

Tice says this is ‘Econ 101’ and he is right. One of the very first textbooks I used on my undergrad was Dobson and Palfreman’s Introduction to Economics, and there is tax incidence on pages 65 and 66. As Tice says, “taxes imposed on the makers and/or sellers of goods are not merely paid by the enterprises themselves (Chinese export operations, say, and U.S. importers) but are passed on to, among others, ‘consumers’ in the form higher prices”

And this logic does not apply just to tariffs, as Tice points out, but to other taxes. The corporation tax, for example, is not actually paid by corporations. The burden – the incidence – falls mostly on workers in the form of lower wages. When you hear someone talk about taxing ‘the rich’ by raising taxes on corporations, they are ignoring the tax incidence. It isn’t the owners-stockholders who will pay the tax but the workers.

Everything Tice says in his article is unobjectionable economics. Nevertheless, it drew a spirited response from Prof. Louis D. Johnston at Minn Post, although whether he had actually read Tice’s article thoroughly before responding is doubtful, as Tice made clear in a response to the response.

John Phelan is an economist at Center of the American Experiment. 

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