Taxation and Trade

Arindam Das-Gupta

Outline - 8 effects on trade Taxes can cause trade Trade taxes reduce trade and welfare Differential tariffs distort production and

trade patterns Tariffs increase non-traded goods demand Trade taxes cause smuggling and forex black

markets Costly customs procedures reduce trade –

like a tariff Trade liberalisation can boosts revenue – or

not Trade effects of different domestic taxes

depend on incidence

Outline - plus 7 more... Can VAT revenue replace lost trade tax

revenue? Maybe or maybe not. Taxes distort investment in exports -

including services International incidence of tax depends on

monopoly power in traded goods Tax competition or tax relief can distort factor

movements instead of trade Tax havens reduce tax bases and are being

cooperatively combated Globalization reduces domestic tax bases Other policy instruments can also impact

international trade

Importance of trade and trade taxes

0

20

40

60

80So

uth

Asi

a

Eas

tA

sia

&

Wor

ld

OE

CD

TradeTaxes (%ofRevenue)

Trade (%of GDP)

Importance of trade and trade taxes

0

50

100

150

200

250

300

350In

dia

Bang

lade

sh

Pakis

tan

Chin

a

Nepa

l

Kore

a, R

ep.

Indo

nesia

Sri L

anka

Papu

a Ne

wGu

inea

Philip

pine

s

Viet

nam

Thai

land

Mong

olia

Maldi

ves

Malay

sia

Sing

apor

e

Tra

de (%

of G

DP

)

012345678910

Tra

de ta

xes

(% o

f GD

P)

Trade Taxes on international trade

Taxes can cause trade: Example 1

A: No tax equilibrium

Tax imposed on X1

X1: exported good post tax

X2: imported good post taxB: Post tax equilibrium

Trade creation and diversion with customs unions: Example 2

Customs union: levy lower (or no) import tariffs on members and common tariffs on non-members

Leads to increased trade between members (“trade creation”)

Less trade with non-member countries (“trade diversion”)

Trade taxes and trade

Impact trade and welfare negatively Non-tariff barriers (quotas) have similar

effects - if quota is auctioned by govt.– else quote revenues go to quota holder and

there are income effects on trade– rent seeking may also occur

Differential trade taxes or other taxes distort trade patterns

Effects of tariffs on trade and welfare

B+A: welfare loss from tariff tm

Effects of export taxes on trade and welfare

B+A welfare loss from export tax te

Differential tariffs distort production and trade

Good 1 - High Tariff Good 2 - Low Tariff

Tariffs increase non-traded goods and reduce traded goods production

Tp

**Tp*Tp

NTp

**NTp*NTp

Traded Goods Non-Traded Goods

Trade taxes cause smuggling and forex black markets

Smuggling– Real resources used to avoid payment of tax– Nexus with corruption– Are bribes more efficient than smuggling?

Impact on forex black markets (“hawala”) with exchange rationing leading to a forex premium– premium serves as “surrogate tariff”– tariff increase causes premium to fall

Trade tax administration and trade Customs procedures impact imports and

exports like trade taxes - without revenue benefits.

Customs streamlining can boost trade and so trade tax revenue.– Customs cooperation also facilitated by

harmonised goods classification and automation Some customs reforms can help curb under-

over-invoicing and smuggling, increasing revenue - has conflicting effects on trade.– Pre-shipment inspection may help or hurt

government revenue

Revenue effects of trade liberalisation If trade causes growth, revenue should

rise if buoyancy is positive. Replacing QRs by tariffs should boost

revenue Both in theory and empirically lower

tariffs impact on trade tax revenue indeterminate: Laffer curve

Sufficient tariff lowering must reduce revenue

Theory and empirical evidence on possibility of replacing tariff revenue by domestic tax revenue conflict.

Domestic taxes and trade Key difference between domestic consumption

taxes and import duties: import duty discriminates against imports.

Backward shifted taxes are borne by inputs and do not impact trade.

Extent of forward shifting critical: Non-trade taxes effect trade if they are forward shifted to buyers of products via higher prices– E.g.1 Corporate taxes can raise capital costs and so

production costs • Foreign tax credits limit importance of this on trade

(greater impact on factor flows)– Eg. 2 Taxes on intermediate inputs, (fuel excise) can

have similar effects - they cannot be credited.– If these tax-induced effects are sector specific, they

impact relative costs and trade via impacts on both consumption and production.

Impact of forward shifted production taxes on trade

Backward shifted taxes and mixed shifting

Studies for the US suggest this case obtains via the corporation tax– No direct impact on international trade– Impact is through lowered domestic

investment Resource taxes also usually shifted

backward Wage taxes part forward and part

backward shifted

Tariffs versus VAT Are broad-based consumption taxes superior

to trade taxes? – Keen-Ligthart: If all goods are tradeable then a

tariff cut that raises the value of domestic production plus combined with higher consumption tax which leaves domestic prices the same leads to higher welfare and revenue!

• VAT base (consumption versus imports) is larger than tariff base: To raise a given revenue a lower tax rate can be used: less distortion.

• But a VAT is seldom a “pure” VAT: itself distortionary:

• More evasion prone in poor countries?• Revenue result requires qualification with non-

traded goods or intermediate goods• Can fail with imperfect competition if tariff revenue

is lost as rent to exporters

Price neutral replacement of a tariff with a consumption tax

Production with tariff at b

Production with VAT at e

abcd: tariff revenue

acfg: VAT revenue

Revenue effect of VAT replacing tariffs: empirical evidence

More open economies introducing a VAT may lose revenue (Ebrill et. al. 2001).

Finding contrary to theory suggesting importance of caveats (non-traded & intermediate goods, imperfect competition).

VAT may have boosted export tax revenue due to credit-invoice mechanism (Ebrill, et. al., 1999).

Caveat: lowering tariffs somewhat does not always lead to revenue loss (e.g. less smuggling/bribes).

Tax shifting and its impact on production costs and trade

Forward Shifting and Impacts on Production Costs and Trade Tax How Tax is

Shifted Incidence Trade Impacts

Corporate Tax

Higher cost of capital

Part shifted forward to consumers, part backwards to capital owners

Costs of K-intensive goods relatively more affected: OECD Exports, imports of developing countries

Excise Taxes on fuel

Higher fuel prices for energy users

100% forward shifting typically assumed

Energy intensive: OECD exports & developing country imports retarded

Payroll/ Social Security

Higher gross of tax wage rates

Depends on demand-supply elasticities for labour - as for Corp Tax

Exports of labour intensive products retarded

Resource Taxes

Not shifted or shifted backwards

Backward shifted to resource owners

None

Source: Whalley (2002)

Domestic tax effects on services;Tax exporting

If non-traded goods bear a lower effective tax than traded goods (e.g. housing, services) then more investment in non-traded goods and so less demand/supply of traded goods.

Services tend to be lightly taxed so service taxation promotes trade in goods

Export of services increasingly important: Service taxes reduce export cost advantage.

If taxes are origin based then exporting countries are able to “export” tax - revenue benefits if countries are not “small”.

Globalization Issues

Tax competition, double tax relief and factor movements

If tax competition succeeds in attracting foreign factors (FDI or skilled labour) this may act as a substitute for trade.

Similarly with tax incentives Tax treaties and unilateral tax sparing

can have similar effects. Tax havens have no “real” effect but

lead to lower revenues in non-haven countries due to changed ownership

Tax havens: The OECD’s Harmful Tax Competition (HTC) Initiative Tax havens: countries with tax regimes designed

to attract investments/transactions that are motivated by tax avoidance with laws of other countries.

OECD: Criteria for identification of HTC by “uncooperative tax havens”.– Secrecy laws/practices to prevent exchange of

information for tax purposes with other governments on its residents

– Lack of transparency (e.g. accounting/auditing rules lax or non-standard).

– No requirement that activity be substantial for preferential tax.

OECD to adopt common defensive measures.

Effects of globalization on tax bases Globalization my decrease national

revenue bases, especially of poor countries.– Most countries will find it increasingly

difficult to tax mobile factors - and capital/skilled labour mobility is increasing.

– International pressure to also decrease trade taxes most important in poor countries

– OECD restrictions on attracting legal ownership

Likely increase in importance of consumption taxes and wage taxes

Conclusions

Trade off between growth from globalization and fiscal capacity

Plight of immobile factors With globalization, importance of tax

information exchange Search for new revenue sources Impact of regulations and expenditure

versus taxes