Can tariff and tax reforms deliver welfare improvements under imperfect competition?

Abstract

This paper using a trade model of imperfect competition and product differentiation, examines the welfare effects of two popular tariff-tax reforms: (i) a tariff cut combined with an equal increase in the consumption tax and (ii) a tariff cut combined with an increase in the consumption tax that leaves the consumer price of the imported good unchanged. It is shown that if tax revenues are lump-sum distributed and firms compete over prices, then coordinated tariff-tax reforms improve welfare for a low degree of product differentiation, whereas these reforms are welfare-reducing for any degree of product differentiation under Cournot competition. When, instead, revenues are used to finance the provision of public goods, then the total effect of these reforms on welfare depends, under plausible assumptions, on the strength of the consumer's valuation of the public good.

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