Welfare Cost of Raising Tariffs: Evidence from Iran

Increasing tax rates affects both on marginal consumptions and tax compliance. When talking about trade taxes, non-compliance could be either in the form of illegal imports (evasion) or seeking for exemptions (avoidance). Using Iran’s trade data, we are able to quantify each of the above channels. In addition to highly volatile and wide-ranging set of tariffs, this country is neither a WTO member nor a member of any other multilateral agreement; therefore tariffs are set noncooperatively. We measure illegal imports similar to the Fisman and Wei (2004). We document that the country is on the increasing slope of the Laffer curve. However, any change in statutory tariff rates ends up only in 34% more custom income. The rest of the impact is neutralized by decrease in aggregate imports due to behavioral impact (3%), increase in evasion (19%) and discrepancy between actual and statutory tariffs (43%). In order to quantify welfare implications of tariff changes, we extend Chetty (2009) to a small open economy. Our empirical estimations show that welfare decreases by increase in tariffs. Within the unit measure of imports in 6 digit HS-country ($1,780,000), any 1 unit increase in tariff rates decreases welfare by about $300,000. This number increases when distinguishing goods with higher tariffs (>30% advalorem), or consumptions goods; the latter is subject to higher tariffs due to setting effective tariffs, which is officially obligated in Development Plans.