Can Trade Taxes be a Major Source of Government Revenue?

Abstract

Abstract The tariff-for-revenue argument has been invoked repeatedly in recent years to justify protectionism. It is motivated by the belief that a country with market power can use trade taxes to raise revenue from foreign consumers and producers. This paper develops a new sufficient statistics methodology to evaluate this claim for a wide range of countries. I show that (a) even large countries have limited market power. (b) So, before retaliation by trading partners, the average country can beneficially replace only 16% of its domestic tax revenues with trade taxes. (c) After retaliation, however, 50% of the collected trade tax revenues disappear, governments are forced to increase domestic taxes to counter their shrinking tax base, and real gross domestic product drops across-the-board by an average of 7%. On the flip side, these findings indicate (d) the gains from multilateral trade agreements are also 30% larger once we account for the fiscal cost of trade wars.