Optimal Tariffs under a Revenue Constraint

This paper examines the optimal tariff structure under a revenue constraint. When a fixed level of tax revenue has to be collected from the tariff alone, no adjustment in tariff rates can achieve an efficient resource allocation, even in a small open economy. Hence, the optimal tariff problem arises under a revenue constraint. We show that the revenue-constrained optimal tariff structure is characterized by the following two rules: (i) the optimal tariff rate is lower for the import good that is a closer substitute for the export good, and (ii) the stronger the cross-substitutability between imports, the closer the optimal tariff is to uniformity. This provides a theoretical explanation for the finding in empirical studies that the efficiency loss from a uniform tariff structure is negligible.