Taxation and Trade
Arindam Das-Gupta
Outline - 8 effects on trade
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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...
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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
80
Trade
Taxes (%
of
Revenue)
60
40
20
Trade (%
of GDP)
OECD
World
East
Asia &
South
Asia
0
Trade
Taxes on international trade
Singapore
Malaysia
Maldives
Mongolia
Thailand
Vietnam
Sri Lanka
Papua New
Guinea
Philippines
Indonesia
Korea, Rep.
Nepal
China
Pakistan
Bangladesh
India
Trade (% of GDP)
350
300
250
200
150
100
50
0
10
9
8
7
6
5
4
3
2
1
0
Trade taxes (% of GDP)
Importance of trade and trade
taxes
Taxes can cause trade: Example 1
A: No tax equilibrium
Tax imposed on X1
X1: exported good post tax
X2: imported good post tax
B: Post tax equilibrium
Trade creation and diversion with
customs unions: Example 2
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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
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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
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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
p
p
T
T**
p
T*
Traded Goods
NT Non-Traded Goods
p
p
p
NT**
NT*
Trade taxes cause smuggling and
forex black markets
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Smuggling
– Real resources used to avoid payment of tax
– Nexus with corruption
– Are bribes more efficient than smuggling?
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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
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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
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Some customs reforms can help curb underover-invoicing and smuggling, increasing
revenue - has conflicting effects on trade.
– Pre-shipment inspection may help or hurt
government revenue
Revenue effects of trade liberalisation
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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
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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
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Studies for the US suggest this case
obtains via the corporation tax
– No direct impact on international trade
– Impact is through lowered domestic
investment
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Resource taxes also usually shifted
backward
Wage taxes part forward and part
backward shifted
Tariffs versus VAT
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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 nontraded 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
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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).
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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
Incidence
Trade Impacts
Shifted
Corporate
Higher cost of
Part shifted forward
Costs of K-intensive goods
Tax
capital
to consumers, part
relatively more affected:
backwards to capital OECD Exports, imports of
owners
developing countries
Excise
Higher fuel prices 100% forward
Energy intensive:
Taxes on
for energy users
shifting typically
OECD exports & developing
fuel
assumed
country imports retarded
Payroll/
Higher gross of
Depends on demand- Exports of labour intensive
Social
tax wage rates
supply elasticities for products retarded
Security
labour - as for Corp
Tax
Resource
Not shifted or
Backward shifted to
None
Taxes
shifted backwards resource owners
Source: Whalley (2002)
Domestic tax effects on services;
Tax exporting
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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
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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
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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.
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OECD to adopt common defensive measures.
Effects of globalization on tax bases
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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
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Likely increase in importance of
consumption taxes and wage taxes
Conclusions
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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