Discussion paper

DP15697 A Second-best Argument for Low Optimal Tariffs

We derive a new formula for the optimal uniform tariff in a small-country, heterogeneous-firm model with roundabout production and a nontraded good. Tariffs are applied on imported intermediate inputs. First-best policy requires that markups on domestic intermediate inputs are offset by subsidies. In a second-best setting where such subsidies are not used, the double- marginalization of domestic markups creates a strong incentive to lower the optimal tariff on imported inputs. In a 186-country quantitative model, the median optimal tariff is 10%, and negative for five countries, as compared to 27% in manufacturing from the one-sector, optimal tariff formula without roundabout production.

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Citation

Caliendo, L, R Feenstra, J Romalis and A Taylor (eds) (2021), “DP15697 A Second-best Argument for Low Optimal Tariffs”, CEPR Press Discussion Paper No. 15697. https://new.cepr.org/publications/dp15697