Inequality, Redistribution and Optimal Trade Policy: A Public Finance Approach

58 Pages Posted: 16 Nov 2018

See all articles by Roozbeh Hosseini

Roozbeh Hosseini

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics

Ali Shourideh

University of Pennsylvania - Finance Department

Date Written: October 21, 2018

Abstract

In this paper, we explore the relationship between optimal trade and redistributive policies when the gains from trade are unequally distributed. We use a competitive trade model with input-output linkages where trade affects relative wages and the reallocation of workers across various sectors is frictional. We study how income taxes and trade policies should be designed in order to balance the efficiency gains from trade with the costs associated with the resulting increased inequality. We show that for a large class of global production structures, the global trade of goods and services must be undistorted even when personal taxes are incomplete. In other words, barriers to trade such as tariffs are never optimal. In contrast, producer taxes in the form of value-added taxes (VAT) that are differentially levied on different sectors play a crucial role in redistributing the gains from trade. We provide formulas that highlight the main determinants of optimal VAT and non-linear income taxes. Finally, in a quantitative version of our model, we study the optimal response to the rise of China in international trade. Our quantitative analysis establishes that differential VAT taxes play the main role of redistributing the gains from trade, while income taxes do not.

Suggested Citation

Hosseini, Roozbeh and Shourideh, Ali, Inequality, Redistribution and Optimal Trade Policy: A Public Finance Approach (October 21, 2018). Available at SSRN: https://ssrn.com/abstract=3159475 or http://dx.doi.org/10.2139/ssrn.3159475

Roozbeh Hosseini

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics ( email )

Athens, GA 30602-6254
United States

Ali Shourideh (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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