Input tariffs and duty drawbacks in the design of tariff reform

This paper analyzes the welfare effects of raising tariffs on inputs, complemented by duty drawbacks on exports, in a small open economy. The main findings of the paper are as follows. First, a tariff on the input unaccompanied by duty drawbacks on exports works like a production tax at different rates on goods using the input. The effect of such a tariff on welfare is ambiguous in general even if the tariffs on final imports are lowered so as to maintain a constant revenue. Second, a tariff on the input accompanied by a duty drawback on exports is equivalent to a production tax on the final import and a consumption tax on the export using the input. A small change of this type improves welfare unambigously provided the export and import goods using the input are substitutes in both production and consumption. This result holds even if the policy change leads to a contraction of exportables not using the input. Finally, the effect of a large tariff on the input accompanied by a duty drawback on exports is ambiguous in general but a presumption can be established in favor of a favorable effect. The last two results are reinforced by the presence of a revenue constraint.