The costs of restrictive trade policies in the presence of factor tax distortions

This paper uses a numerical general equilibrium model to examine the quanti tative importance of pre-existing factor tax distortions for the welfare ef fects of tariffs and import quotas. The presence of pre-existing taxes can greatly raise the costs of these policies, possibly by over several hundred percent. For a tariff much of this extra cost can be offset if tariff reve nues are used to reduce distortionary taxes. Hence there can be a large cos t discrepancy between tariffs and quotas. The optimal tariff for a country with market power in trade can be reduced to zero, unless revenues finance cuts in distortionary taxes.