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
80
Trade
60 Taxes (%
of
40 Revenue)
20 Trade (%
of GDP)
0
World
South

Asia &

OECD
Asia
East
 Trade (% of GDP)

0
50
100
150
200
250
300
350
India
Bangladesh
Pakistan
China
taxes

Trade
Nepal
Korea, Rep.
Indonesia
Sri Lanka
Papua New
Guinea
Philippines
Vietnam

Taxes on international trade

Thailand
Mongolia
Maldives
Malaysia
Singapore
0
1
2
3
4
5
6
7
8
9
Importance of trade and trade

10

Trade taxes (% of GDP)

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

 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
T NT Non-Traded Goods
p Traded Goods p

NT**
p T** p
NT*
p T* p
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 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
 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