ABSTRACT
This paper develops a model of two trading countries which are related by a bilateral production externality. Necessary conditions which must characterize an optimal tax structure from the point of view of one country are solved for and interpreted. Second, the model serves as a vehicle to extend the theory of corrective taxation in the case where only one policy instrument is available to deal with several distortions simultaneously. It is pointed out that the ranking of alternate second best tax structures typically depends upon which good is imported and which good is exported.
