Revisiting the cost of protectionism: The role of tax distortions in the labor market

Most studies of the welfare impacts of trade policy have ignored interactions between these policies and pre-existing distortions from the income tax. This paper demonstrates that when these interactions are taken into account, the potential gains or losses from tariffs, import quotas, or voluntary export restrictions are significantly magnified. However, as long as the trade barrier doesn't generate rents for domestic households, the optimal level of the trade barrier is unchanged from the first-best case. Trade policies which do increase domestic rents, either in the form of quota rents or rents to fixed factors in production, suffer an additional efficiency cost, and the optimal policy in this case is less strict than in the first-best case. (C) 1999 Elsevier Science B.V. All rights reserved.