From a customs union to a common market: the need for factor-tax harmonization

Abstract

Wooton (1988) demonstrates that a movement of a small customs union towardsa common market may result in a welfare loss if the common external tariff rates are not zero. The present paper, building on Wooton's model, demonstrates that even if the common external tariff rates are zero, the movement towards a common market may still result in a welfare loss if the tax rates on factor's rates of return are not equal among partners. Within two special models, the analysis also demonstrates that when the tax rates on factors' rates of return are equal among member countries, then the movement towards a common market is optimal, regardless of whether or not the common external tariff rates are zero. © 1992.