Economists Are Shocked, Shocked by Who Is Paying the Tariffs

In fact, a lot of the cost does land on foreigners.

It was, by any measure, a lot of red ink. When Volkswagen announced its third-quarter profits at the end of October, the German auto giant said it anticipated heavy losses for this year. The reason? It is taking a 5 billion euro hit from tariffs imposed in the American market. Likewise, the German sportswear manufacturer Adidas warned of a 120 million euro hit to its earnings, in part because the levies its trainers now face in the United States, while Toyota warned of a $9 billion hit from tariffs.

For anyone following the corporate earnings season over the last month, a clear theme has emerged from the giants of European and Asian industry: President Trump’s tariff regime is starting to significantly reduce their profits. But hold on. Weren’t we told that tariffs would simply be passed straight on to American consumers in the form of higher prices? That they were a tax on ordinary working people? Instead, it is already becoming clear that at least some of the costs are being paid by foreign conglomerates and even by foreign governments.

When President Trump first unveiled his sweeping tariff regime on (the admittedly oddly named) “Liberation Day” back in April, the economic establishment went into a predictable meltdown. From the editorial pages of the Financial Times to the seminar rooms at Harvard, the verdict was unanimous: this was simply a tax increase by another name, and American consumers would have to foot the bill. The Peterson Institute joined the chorus in predicting disaster. True, the declarations were always hedged with plenty of academic caveats. But the overall impression was that tariffs would prove catastrophic for the American economy.

And yet, several months into what amounts to the most dramatic shift in American trade policy in generations, the evidence is starting to tell a remarkably different story. Yes, the tariffs are a tax. But they are a tax that’s being paid primarily by foreign companies and foreign governments, not by the American consumers we were all supposed to be weeping for. And that changes everything.

True, the tariffs regime was only fully implemented in August, and Trump has cut plenty of side deals that may mitigate their impact. Even so, the numbers speak for themselves. The U.S. now imposes an average tariff of 18.6%, the highest since 1933 according to Yale’s The Budget Lab. If the conventional wisdom were correct, we should be witnessing an inflationary spiral. American families should be groaning under the weight of soaring prices across multiple categories of consumer goods. For example, the New York Fed chief John Willians warned soon after Liberation Day that inflation could climb to 4%, while fellow Fed Governor Christopher Waller said it could reach 5%.

Instead, inflation is running at roughly 3%. Let that sink in for a moment. The government imposes a massive round of import levies and inflation barely budges. The Harvard Business School tariff tracker, which has been monitoring price changes across affected sectors, estimates a “pass-through” rate of approximately 20%, meaning that only one-fifth of the tariff costs are actually showing up in consumer prices. Even that figure may be generous as it includes some one-off adjustments that are unlikely to persist.

Certainly, there are pockets of pain. The automotive sector has seen price pressures, particularly in parts and components. Some specialized industrial equipment has become more expensive. But the apocalyptic scenarios painted by opponents simply haven’t materialized. American consumers are not, as predicted, bearing anything close to the full burden of the trade barriers.

Orthodoxy Meets Reality

So what’s actually happening? Where is the money going? The answer reveals three fascinating dynamics that the economic orthodoxy, as it so often does, failed to anticipate.

First, and perhaps most importantly, profit margins in export markets had become grotesquely inflated. For years, foreign manufacturers have been reaping spectacular profits in the American market. Companies never reveal the precise margins they are making; it would give too much information to their competitors. But it seems the German automakers made huge profits selling high-end vehicles in the U.S., while French and Italian luxury goods manufacturers were even more brazen, with some fashion houses marking up products destined for American retailers by 200% or more.

Profits on microchips may have been higher still, while even the everyday items that fill Walmart and Target shelves may have been surprisingly profitable for foreign firms. Why? Because they could. Over several decades, American domestic competition was systematically hollowed out. Manufacturing capacity migrated overseas. Local rivals withered. The playing field had tilted so dramatically that foreign exporters found themselves operating in what was effectively a low-competition environment, and they were able to charge premium prices with impunity. Of course, in some cases that has allowed them to pass on the tariffs as price increases, but it has also allowed them to absorb the cost themselves.

Tariffs have changed the game. German automobile manufacturers, facing 25% duties on vehicles shipped to American ports, have quietly absorbed much of the cost rather than price themselves out of the lucrative U.S. market. The same pattern emerges across other industries. South Korean electronics firms appear to have trimmed margins rather than pass costs on to American retailers, while even Chinese manufacturers, despite Beijing’s bluster, have found ways to absorb tariff costs through reduced profits rather than abandoning market access. Especially in Asia, many of the major exporters into the U.S. market are privately owned, so there is very little publicly available data on what kind of profit margins they are making. But the clues are all over the place if you care to look. Only a small fraction of each tariff has been passed on to the American consumer, and that must mean it is being absorbed somewhere else. According to the Harvard’s Pricing Lab, prices of imported goods rose by 5.4% from March to September as tariffs were imposed, compared with 3% for domestic goods, so some of the tariffs were passed on but far from the full cost. In other words, the market has adjusted, just not in the way the textbooks predicted.

There is a second dynamic at work that is even more intriguing: government subsidies. When a tariff threatens access to a strategically important market, foreign governments often step in to cushion the blow. That may be especially true of China, where the ruling Communist Party views trade through an explicitly geopolitical lens. Take the solar panel industry for example. The U.S. government has imposed tariffs on panels for more than a decade in an attempt to safeguard its domestic industry, but that has done little to lower imports, in part because Chinese companies have shifted production to lower-tariff countries, but also because the government has absorbed the costs instead.

In reality, the Chinese government, through its state-owned banks and provincial development funds, extended cheap credit to manufacturers and offered export subsidies that effectively neutralized the tariff’s impact. Beijing wasn’t interested in maximizing short-term profits; it wanted to maintain market share and preserve its dominance in a strategic sector. Likewise, the European Union, though it would never admit it publicly, has engaged in similar behavior. When American steel tariffs threatened major European producers, several governments quietly ramped up support through a range of industrial policy measures including research grants, favorable loans, and export credit guarantees. The official line was always about innovation and competitiveness. But the practical effect was to help manufacturers absorb tariff costs and maintain their share of the crucial American market.

Again, the true figures are never revealed. But it is perfectly possible that foreign government support to exporters affected by American tariffs now runs into the tens of billions of dollars annually. That money previously came from American wallets, and is now being paid instead by taxpayers in Beijing, Berlin, and Tokyo. It’s a remarkable wealth transfer that’s absent from the mainstream debate over tariffs. In standard economics textbooks, tariffs may well be paid by consumers in the country that imposes them. In the real world, trade policy is dictated as much by politics as by anything else, and that means the tariffs are often absorbed elsewhere.

Finally, and perhaps most encouraging for those who believe in American dynamism, is the entrepreneurial response. Tariffs create opportunities and American business owners have already shown signs that they will prove remarkably adept at seizing them. Of course, where the tariffs are absorbed by foreign corporations or governments, that opportunity is reduced. But where it isn’t, domestic businesses can step into the market.

We are already seeing a huge rise in investment in American manufacturing as European and Asian conglomerates realize that is the only way to circumvent U.S. tariffs. The British-Swedish pharmaceutical giant AstraZeneca has announced a $50 billion investment to build plants in the U.S. Taiwanese semiconductor manufacturer TSMC has announced a $100 billion investment to start making chips in America. There have even been reports that Swiss chocolatier Lindt may shift production of its Easter Bunnies to America. Over the next couple of years, we will see a wave of tariff-driven foreign investment, and that will both boost growth and lower the prices here at home.

The more interesting response, however, will be from American start-ups. If the Vietnamese or Polish exporter now faces significant tariffs, there is an opportunity for a new American company to step into the market instead. Sure, they will have to figure out ways to compete on cost. But with tariffs coming alongside advances in artificial intelligence and robotics, that might well be a lot easier than it has been for most of the last 20 years. Economic history tells us that when a market opportunity opens up, entrepreneurs will very quickly find ways of exploiting it. As tariff-protected domestic markets become profitable, new entrants will appear. Innovation will accelerate and efficiency will improve.

From Beijing to Washington

So far, tariffs are generating an extra $30 billion for the U.S. Treasury every month. If that is maintained—and there is no reason to think it won’t be—that translates into roughly $360 billion in annual duties on foreign goods, a staggering sum by any measure. If the critics were correct, that would represent a $360 billion tax increase on American families. But if the pass-through rate is genuinely around 20%, only about $72 billion is actually falling on American consumers. The remaining $288 billion? That’s being absorbed by foreign exporters and foreign governments.

Think of it this way: it’s a $288 billion annual wealth transfer from the Chinese Communist Party, the German exchequer, and various other foreign entities to the American treasury. Money that would otherwise have gone to Beijing or Berlin is instead going to Washington. Profits that would have been earned by foreign shareholders are instead either staying with American consumers (in the form of stable prices) or being captured by American companies (as they rebuild market share).

Is that a good policy? It probably depends on who you are. If you’re an economics professor wedded to models that assume perfect competition and frictionless markets, you probably still hate tariffs. If you’re a corporate executive who benefited from the old system of globalized supply chains and cheap foreign labor, you’re likely apoplectic. If you’re a foreign manufacturer who enjoyed years of high-margin American sales, you’re certainly unhappy. But if you’re an American worker in a revitalized factory, you might feel differently. If you’re a Treasury official watching tariff revenue flow in while inflation remains subdued, you might think the policy is working out pretty well. If you’re concerned about American industrial capacity and strategic independence, you might conclude that some short-term disruption is a worthwhile price for long-term resilience.

The broader point here is about interests. For decades, American trade policy was conducted with the primary goal of minimizing prices at any cost, even if it gutted communities, created dependence on potential adversaries, and led to a massive trade deficit. The operating assumption was that all economic actors would benefit more or less equally from open markets, and that any deviation from free trade orthodoxy was crazy.

Reality has proven slightly more complicated. Open markets, it turns out, benefit some sectors far more than others. And when foreign trading partners subsidize exports, manipulate currencies, or operate under entirely different political and economic systems, the theoretical benefits of unfettered trade can evaporate very quickly. Tariffs represent a different approach, one that explicitly prioritizes American interests over abstract economic theories. They’re a tool for rebalancing relationships, for rebuilding capabilities, and for ensuring that competition occurs on something closer to fair terms.

Are they perfect? Of course not. Some sectors face genuine challenges. Some products genuinely are more expensive. For example, according to data from the Bureau of Labor Statistics, the price of audio equipment rose by 14% between March and August, dresses by 8%, and tools and equipment by 5%. Yet even this may represent a long-term opportunity for American entrepreneurs as prices rise for European and Asian imports.

The policy creates winners and losers, as all policies do. But the apocalyptic predictions have not come to pass, and the benefits—from job creation to revenue generation to strategic repositioning—are increasingly apparent.

Rewinding to the 1850s, tariffs accounted for around 80% of all federal revenues. The catch is that the government is far larger today than it was back then. It is unlikely that tariffs could ever match that figure again. But they could replace the $540 billion the Treasury collects from corporate tax. In effect, American businesses would then be exempt from federal taxes while foreign corporations would pay instead. That would massively boost the competitiveness of the nation’s businesses.

The most significant point is surely this: There’s nothing inherently wrong with a government robustly promoting the interests of its own citizens. Every successful nation in history has done exactly that. The question is not whether governments should pursue national interests, but how they should do so and whether the tools they employ actually work. On that score, the tariff experiment is turning out rather differently than the experts predicted. Yes, tariffs are a tax. But they’re a tax that’s being paid, to a remarkable degree, by those the policy was designed to target: foreign manufacturers enjoying excessive profits and foreign governments pursuing strategic trade objectives.