Commodity taxes and rent extraction

It is difficult for WTO member countries to raise tariffs unilaterally under current WTO regulations. Therefore, given a constant tariff rate, we examine the impacts of two commodity taxes, an ad valorem tax and a specific tax, on the rent-extracting effect regarding the foreign firm and on the protection effect regarding the domestic firm. We obtain two main results. First, the government can extract more profits from the foreign firm by imposing an ad valorem (a specific) tax, when the tariff rate is low (high); and second, when the tariff rate is low, an ad valorem tax is welfare superior to a specific tax while the reverse may occur when the tariff rate is high. This demonstrates that the magnitude of the tariff rate is crucial when the government chooses the commodity tax scheme.