This chapter shows that in the presence of tourism, the traditional policy prescription, free trade in goods and the standard Pigouvian tax on pollution, is not optimal for a small open economy. Foreign tourists consume mainly local non-traded goods in the tourist-receiving economy. Inbound tourism converts formally non-traded goods into tradables, generating a tourism terms-of-trade effect. Owing to this favourable effect ,positive tariffs and stricter pollution taxes can actually improve welfare of domestic residents. The optimal rates of tariffs and pollution taxes are derived and explained for the economy with tourism. These positive rates are confirmed by simulations.