Sufficient Statistics for Welfare Implications of Tariff Raise with Noncompliance

The impact of Illegal trade on welfare is vastly investigated in different theoretical models. We add to this literature by introducing exempt-tariff imports, known as tariff avoidance. Moreover, we utilize our model with an empirical quantification. Our model assumes a small open economy in which agents can endogenously choose between three methods of importing: legally with paying tariffs, legally exempted imports, and illegal trading. Those agents who seek for exemptions or illegal methods burden with opportunity cost, while illegal trading incorporates an additional cost of auditing. We solve the model for equilibriums with and without the two types of tariff noncompliance (i.e., exemption and illegal trade), and obtain sufficient statistics for welfare analysis in each set of results. Results indicate that in equilibrium without illegal trade, the elasticity of tariff-paid import is sufficient to calculate welfare loss associate with tariff raise. Same statistics is sufficient if the economy burdens with exemption. However, with illegal trade, the statistics depends on a weighted average of tariff-paid imports, exempted imports and aggregate imports. Weights are determined by the resource cost associated with the noncompliance. We quantify our theoretical results by using a disaggregated dataset of trade in an economy where both types of noncompliance are responsive to tariff changes. Results indicate that a 1 unit tariff rise reduces welfare by 6%, or 3.6 billion dollar out of total of 60 billion dollar annual imports