Hong Hwang, Ph.D., Economics, National Taiwan University, 21 Hsu Chow Road, Taipei, 10020, Taiwan
This paper departs from the usual Brander-Spencer-Eaton-Grossman framework by taking into consideration the asymmetry between private and social costs, and hence the welfare cost of taxation distortion. It shows that when an export policy causes no taxation distortion, the optimal policy is an export subsidy, no matter whether a specific or an ad valorem subsidy policy is pursued, and the levels of domestic welfare are the same under the two policies. However, when there exists welfare cost of distortional taxation, the optimal policy is an export subsidy under the two policies if the welfare cost is low. As the welfare cost becomes higher, the optimal policy is still an export subsidy under the specific subsidy regime, but it is an export tax under the ad valorem subsidy regime and whether the domestic welfare is greater or not under the former regime than under the latter is ambiguous, depending upon the size of the welfare cost of taxation distortion. Furthermore, when the welfare cost becomes even higher, an export tax becomes optimal under both regimes and the welfare ranking of the two regimes is also reversed.