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Working Paper Summaries (WP/93/1 - WP/93/54)
Article

Summary of WP/93/50: “Optimal Tariffs: Theory and Practice”

Author(s):
International Monetary Fund
Published Date:
August 1993
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This paper examines the theory behind the design of optimal tariffs in a developing economy under various policy objectives (revenue, protection, income distribution, and balance of payments) and the experience of their implementation in a sample of six developing countries. It addresses the central question of whether a case can be made for a uniform tariff structure and, if so, under what circumstances. Theory generally advocates a differentiated tariff structure: it should be differentiated according to the price elasticity of demand for imports under a revenue objective, according to the stage of processing under a protection objective, and according to the income elasticity of demand under an income distribution objective; only under a balance of payments objective would theory call for a uniform tariff structure. In practice, however, inadequate information, administrative convenience, and political economy result in a minimally differentiated tariff structure with about three to five rates. The paper also examines the process of reform, including the revenue and welfare effects of reductions in the maximum tariff and increases in the minimum tariff. Increases in the minimum rate have favorable welfare consequences if coupled with duty drawbacks for tariffs on intermediate goods used in the production of exportables; however, there are practical problems in administering such arrangements.

The experience of reform shows that countries generally aim (1) to simplify their tariff structures by assimilating all charges applied on imports, and to reduce the number of rates, thereby reducing distortions and increasing the transparency of the tariff system; and (2) to reduce the average tariff level and dispersion in effective protection. Tariff structures, before and after reform, are mainly influenced by income distribution and protection objectives, which determine how they are differentiated. A successful reduction in tariff levels often calls for complementary measures--for example, domestic tax reforms and exchange rate action--to alleviate the impact of lower tariffs on the fiscal and external positions. The authorities’ ability and willingness to overcome pressures from special interest groups are also important. Many countries are cognizant of the anti-export bias induced by tariffs and attempt to offset it through duty-drawback or similar schemes.

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