IMPORT RESTRICTIONS, CAPITAL TAXES, AND WELFARE

This paper develops a two-good, small-country, general-equilibrium model with trade restrictions (i.e., a tariff, an import quota, or a voluntary export restraint (VER)), international capital mobility, and taxes on the rate of return to capital. Within this context it examines the price and welfare effects of capital taxes, the second-best policy towards capital in the presence of such trade restrictions, and the welfare implications of trade liberalization in the presence of capital taxes. The analysis demonstrates, among other things, that (i) the optimal policy towards capital is a zero tax when imports are quota constrained, and is a tax under a tariff and a subsidy under a VER when the imported good is capital intensive; and that (ii) an asymmetry exists between trade and capital movements liberalization under the various trade regimes.