Free Entry and Government Revenue Under Trade Liberalization

We examine whether the market under free entry with a certain entry cost can recover the revenue loss following tariff reduction on an intermediate input. We show that there are four possible ranges of entry cost, from high to low, with four different revenue implications following a reduction in tariff: (i) both tariff revenue and profit tax revenue increase without raising the rate of profit tax; (ii) tariff revenue declines but total revenue increases as the increase in profit tax revenue dominates the reduction in tariff revenue; (iii) revenue loss can be compensated by increasing the rate of profit tax; (iv) compensation is not possible with a non-distortionary profit tax