Pareto-improving tariff-tax reforms under imperfect competition

- This paper explores welfare effects of tariff-tax reforms in a duopoly.
- Tariff reductions with consumption tax increases can improve welfare.
- Tariff reductions with production tax decreases always improve welfare.

Constructing a duopoly model with non-constant marginal costs and a strict Pareto criterion, this paper examines welfare effects of world-price-fixing tariff reductions accompanied by adjustments of a domestic tax. If a destination-based consumption tax is used, this reform achieves a strict Pareto improvement under sufficiently decreasing marginal costs. If, in contrast, an origin-based production tax is employed, a strict Pareto improvement holds whether marginal cost is decreasing or not. Thus, we can conclude that tariff-tax reforms that improve the world welfare and are irrelevant of tax bases are possible if the targeted industry exhibits sufficiently decreasing marginal costs.