Efficiency of Decoupled Farm Programs Under Distortionary Taxatioin

When lump-sum taxation is not feasible, decoupled transfers to farmers (which require raising government revenue) will entail welfare loss somewhere in the economy. Assuming the government's objective is to assure a given welfare level for farmers, we show that when decoupling is possible, free trade is always superior to some tariff protection for a small country, even under distortionary taxation. AS expected, for a large country there is scope for an optimal tariff policy that improves the terms of trade. However, we show a separation between the exercise of market power through an optimal tariff, and the interaction of distortionary taxation with transfers to farmers. We conclude that decoupling is usually desirable, even in a distorted economy in which lump-sum taxation is not feasible.