On the Determinants of Optimal Border Taxes for a Small Open Economy

For a small open economy where the government is restricted to raise revenue using border taxes only, the optimal structure of border taxes is considered. As a matter of normalization exports and the supply to the market of the primary factor may be assumed to be untaxed, but that the household use of the primary factor and domestic consumption of the export good cannot be taxed is nevertheless a constraint; this insight provides the key to understanding what determines the optimal tariff structure. The optimal border tax structure is derived for both exogenous and endogenous labour supply, and the results are interpreted in the spirit of the Corlett-Hague results for the optimal tax structure in a closed economy and compared with results from CGE models.