Importers, Market Power and Optimal Tariffs

Importers are few and large, have higher labor productivity and pass through cost changes to prices incompletely. We study optimal tariffs in a model consistent with these facts. Firms pay a fixed cost to import and charge markups that increase with size. Market power implies that importers are too few and too small relative to the efficient allocations. Tariffs amplify this distortion. We derive a formula that relates the optimal tariff not only to the foreign export supply elasticity but also to how much distortions amplify the effect of trade costs on welfare. In our calibrated economy the optimal tariff is negative and decreases with country size.