Abstract
Given that tariffs continue to serve as a primary source of government revenue in many countries, we analyze the optimal indirect tax problem, consisting of commodity taxes and tariffs, under a revenue constraint. This study shows that the optimal commodity tax structure follows the Ramsey rule regardless of whether a country is small or large, which implies that the same optimal commodity tax rules are applied across a range of situations. We also show that the optimal tariffs are not zero, but negative, even in the small country case, which implies stronger support for the World Bank’s recommendation of tariff reductions for a country facing a revenue constraint. In addition, this study analyzes the optimal commodity taxation when tariffs cannot be fully adjusted. Numerical examples demonstrate some of our major findings and the magnitude of the welfare gains by these optimizations for a few countries.
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