Welfare Effects of Trade Liberalization and Coordinated Domestic Sales Tax Reforms Under International Oligopoly

Abstract

This chapter studies the effects of welfare-maximizing and revenue-neutral tariff reduction and coordinated domestic tax reforms carried out until the market is completely liberalized. The setting is an international oligopoly model in which domestic firms, fully foreign-owned subsidiaries, and foreign exporting firms compete in the home market. We show how welfare varies in the process of trade liberalization starting from an initial level to that attained under complete market liberalization. We find that the results on the welfare effects of a one-time infinitesimal tariff–tax reform obtained in earlier studies may not hold when the reform is completed. We next examine the welfare implications of a revenue-neutral tariff–tax reform under a symmetric oligopoly setting. We show that, though there are phases in which the reduction of import tariff and domestic sales tax reform raises both welfare and government revenue, the government must raise the sales tax by a greater amount than that necessary for welfare maximization, as the import tariff approaches zero.