Welfare‐improving Coordinated Tariff and Sales Tax Reforms under Imperfect Competition
Date | 01 May 2016 |
DOI | http://doi.org/10.1111/rode.12244 |
Author | Tatsuya Iguchi,Masayuki Okawa |
Published date | 01 May 2016 |
Welfare-improving Coordinated Tariff and Sales
Tax Reforms under Imperfect Competition
Masayuki Okawa and Tatsuya Iguchi*
Abstract
This paper studies the welfare effects of coordinated domestic sales tax reform associated with a
reduction of the import tariff under imperfect competition. We set up a simple oligopoly trading model
where domestic and exporting firms compete in the home market. We show that, if the initial levels of
import tariff and sales tax are positive, there always exist welfare-improving sales tax reforms. In some
cases, a reduction of the sales tax accompanied by a reduction of the import tariff increases social
welfare, whereas in other cases, raising the sales tax can increase social welfare.
1. Introduction
In the wave of globalization that has taken place in the 1990s, many countries have
decided to liberalize their good and service markets, as well as the capital markets.
In the process, many developing and emerging market countries, in which a
relatively large share of government revenue comes from tariffs, have suffered a
decline of government revenue caused by the reduction of import tariffs. The
governments of these countries must reform their domestic tax systems to
compensate for the decline of government revenue associated with tariff reductions.
In imperfectly competitive settings where the country imports an intermediate
good, Mujumdar (2004) and Haque and Mukherjee (2005) showed that a profit tax
alone can generate sufficient revenue to make up the shortfall in tariff revenue,
ensuring that domestic consumers and the producer are better off than in pre-
reform situations.
1
Naito and Abe (2008) also examined the effects of import tariff and sales tax
reform on welfare and government revenue by extending the number of oligopoly
firms and by introducing an intermediate good. They showed that under some
conditions (or circumstances) the government can increase welfare and government
revenue. McCorriston and Sheldon (2011) also set up a vertically related oligopoly
trading model and examined the effects of a simultaneous reduction of import
tariffs on both final and intermediate goods markets on market access and profits of
the firms on the upstream and downstream stages.
Keen and Ligthart (2005) set up a symmetric duopoly trading model where the
firms have the same marginal cost and compete in the home market. They studied
the welfare effect of two types of import tariff and consumption tax reform: (i)
*Okawa (Corresponding author): Ritsumeikan University 1-1-1 Noji-higashi, Kusatsu, Shiga, 525 8577,
Japan. Tel: +81-77-561-3940; Fax: +81-77-561-3947; E-mail: mokawa@ec.ritsumei.ac.jp. Iguchi: 1-1-1 Noji-
higashi, Kusatsu, Shiga, 525 8577, Japan. The authors thank two anonymous referees for their helpful
comments. This research was supported by a Grant-in-Aid for Scientific Research (No. 24530279) from
the Japan Society for the Promotion of Science and the Ministry of Education, Culture, Sports, Science
and Technology of the Japanese Government.
Review of Development Economics, 20(2), 475–487, 2016
DOI:10.1111/rode.12244
©2016 John Wiley & Sons Ltd
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