Abstract
This is a theoretical and empirical study of trade policy in a small open economy with intermediate inputs. The first part develops a theoretical model and obtains expressions for optimal second-best tariffs on an intermediate input when tax revenue is used to provide a public good and all other taxes are unalterable. In the second part, we estimate, for Pakistan, the optimal tariff on sheet steel using the formula developed in the theoretical part. We find that the current level of tariff is considerably higher than the optimal one even after making generous allowances for government's revenue constraint.
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