Bidding for tariff exemptions in international oligopolies

An advice IMF often gives to its members that open up their markets to trade is to reduce the level of tariffs and to simultaneously increase consumption taxes so as not to lose government revenues. In this paper, we introduce a novel way of reducing tariff rates without losing revenues and without relying on consumption taxes. We propose that the home government imposes a per unit (or ad valorem) tariff $$\tau $$ τ and also auctions off a number of tariff exemptions. The foreign firms that submit the highest bids acquire the exemptions and sell their products in the home market without paying $$\tau $$ τ . The remaining foreign firms, i.e., those who do not acquire exemptions, remain subject to it. We identify market conditions under which this mechanism generates higher revenues for the home government (in comparison with traditional tariff policies) and also higher total home welfare. Among other things, our analysis implies that if the government wants to collect revenues of magnitude $$T(\tau )$$ T ( τ ) , it can do so by announcing a lower tariff rate $$\tau '