Effects of trade and environmental policies on a small open economy, with pollution generated in a sector producing nontradable services consumed by foreign tourists, are examined. The nontradable good is exported via tourism and the induced tourism terms‐of‐trade (TOT) effect becomes an additional source of distortion. An increase in tariffs can cause a TOT improvement and an increase in pollution simultaneously, affecting the condition for a welfare‐enhancing tariff policy. In addition, the welfare effect of a pollution tax reform is strongly linked to whether the reform improves the tourism TOT. The interactions between tourists' spending and domestic welfare are also examined.