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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

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Taxation and trade

Taxation and Trade

Arindam Das-Gupta


Outline 8 effects on trade
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
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




Taxes can cause trade example 1
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
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
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
Effects of tariffs on trade and welfare

B+A: welfare loss from tariff tm


Effects of export taxes on trade and welfare
Effects of export taxes on trade and welfare

B+A welfare loss from export tax te


Differential tariffs distort production and trade
Differential tariffs distort production and trade

Good 1 - High Tariff

Good 2 - Low Tariff


Tariffs increase non traded goods and reduce traded goods production
Tariffs increase non-traded goods and reduce traded goods production

Traded Goods

Non-Traded Goods


Trade taxes cause smuggling and forex black markets
Trade taxes cause smuggling and forex black markets production

  • 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
Trade tax administration and trade production

  • 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
Revenue effects of trade liberalisation production

  • 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
Domestic taxes and trade production

  • 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.



Backward shifted taxes and mixed shifting
Backward shifted taxes and mixed shifting production

  • 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
Tariffs versus VAT production

  • 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
Price neutral replacement of a tariff with a consumption tax production

Production with tariff at b

Production with VAT at e

abcd: tariff revenue

acfg: VAT revenue


Revenue effect of vat replacing tariffs empirical evidence
Revenue effect of VAT replacing tariffs: empirical evidence production

  • 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).



Domestic tax effects on services tax exporting
Domestic tax effects on services; productionTax 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”.



Tax competition double tax relief and factor movements
Tax competition, double tax relief and factor movements production

  • 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: 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
Effects of globalization on tax bases Initiative

  • 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
Conclusions Initiative

  • 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


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