Coordinating Tariff Reduction and Domestic Tax Reform Under Imperfect Competition

Abstract

A major constraint on trade liberalization in many countries is the prospective loss of government revenue. Recent results, however, have established a simple and appealing strategy for overcoming this difficulty, whilst still realizing the efficiency gains from liberalization, in small, competitive economies: combining tariff cuts with point-for-point increases in destination-based consumption taxes unambiguously increases both national welfare and total government revenue. This note explores the implications of imperfect competition for this strategy. Examples are easily found in which this strategy unambiguously reduces domestic welfare.

Keywords: Tariff reform, Tax reform, Imperfect competition, trade liberalization

JEL Classification: F12, F13, H20