Trade Reform with a Government Budget Constraint

Practical trade policy advice must usually recognize that trade taxes help to raise government revenue required for other fiscal purposes. In contrast, the theory of trade policy analysis typically uses the simplifying assumption that tariff revenue is ‘passively’ redistributed, so that a fall in revenue is offset by a fall in the lump sum transfer from the government to the private sector. The passive transfer assumption was perhaps an appropriate simplification in the economies of the Organisation for Economic Cooperation and Development (OECD) in the era of rapid growth, but it is clearly inappropriate to the present concern over public debt along with resistance to tax increases or cuts in the provision of public-sector goods.1 The passive transfer assumption was never appropriate for the governments of developing nations, which are typically dependent on tariff revenue.