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In this paper, we explore the relationship between optimal trade and redistributive policies
when the gains from trade are unequally distributed. We use a competitive trade model
with input-output linkages where trade affects relative wages and the reallocation of workers
across various sectors is frictional. We study how income taxes and trade policies should be
designed in order to balance the efficiency gains from trade with the costs associated with
the resulting increased inequality. We show that for a large class of global production structures,
the global trade of goods and services must be undistorted even when personal taxes
are incomplete. In other words, barriers to trade such as tariffs are never optimal. In contrast,
producer taxes in the form of value-added taxes (VAT) that are differentially levied on different
sectors play a crucial role in redistributing the gains from trade. We provide formulas
that highlight the main determinants of optimal VAT and non-linear income taxes. Finally,
in a quantitative version of our model, we study the optimal response to the rise of China in
international trade. Our quantitative analysis establishes that differential VAT taxes play the
main role of redistributing the gains from trade, while income taxes do not.
