Economic Partnership Agreements: Managing Revenue Implications

1. Economic Partnership Agreements:Managing Revenue Implications Richard Newfarmer Special Representative to the WTO and UN World Bank Geneva, Switzerland July 12, 2007 This presentation was done with Paul Brenton and Erik Von Euxkull, World Bank

2. Many developing countries have found it difficult to recover revenues lost from tariff reductions • High- income countries recover revenues lost from trade liberalization from other sources • On average, middle income countries recover 45-60% of lost tariff revenues • Least developed countries – on average -- recover less than 30% of lost tariff revenues • having a VAT does not guarantee revenue recovery • LDCs have a small initial base for the “hard to collect” taxes and poor collection efficiency …this underscores the importance of integrating revenue concerns into a trade strategy Source: Baunsgaard and Keen (2005)

3. Key Messages • Strategic considerations: The way EPAs affect revenues will depend on the depth and sequencing of tariff reforms. But the path of tariff reforms should be guided by a strategy to improve competitiveness, and only secondarily by revenue considerations. • Methodological considerations: Measuring prospective losses depends on assumptions -- and many studies over-estimate losses. • Policy considerations: Policies to replace lost revenues should be part of tax modernization and integrated into a competitiveness strategy.

4. Regional trade agreements that have succeeded in promoting growth and regional integration share several characteristics… • Design • Low external tariff barriers • Nonrestrictive rules of origin • Wide product coverage with minimal exemptions • Regulated liberalization of services • Facilitating trade at borders • Appropriate rules • Implementation: Avoiding paper agreements ….Open regionalism Source: World Bank, 2004; Schiff-Winters, 2002

5. Effect on revenues depends on depth, sequencing and pace of tariff reforms An illustrative pro-development, phased tariff reform could have three phases of 5 years each… • Phase 1 - 2: Eliminate all internal barriers in CU/FTA to promote integration. • Advantages: promotes regional integration, reinforces trade facilitation and reduction in border crossing delays, revenue losses minimal, provides attractive, wider investment arena • Phase 1 - 2: Bring down MFN peak tariffs to average • Advantages: promotes efficiency, intra-African trade, introduces more competition, stimulates exports; moves toward EU common tariff on MFN basis • Phase 2 - 3: Bring down MFN average levels to East Asian levels • Advantages: promotes exports by reducing anti-export bias • Phase 3: Phased elimination of duties on EU products • Advantages: backloading minimal trade diversion, wider competition,

6. ACP can use EPAs to leverage domestic reforms, beginning with tariff peaks High tariffs undermine competitiveness, often protect monopolies, risk trade diversion, and impede intra-African trade… Average MFN weighted tariffs Note: EPA Tariffs are import-weighted at the country level, then weighted by GDP at EPA averages Source: UN TRAINS, accessed through WITS

7. East Asia ECA LAC SSA South Asia MNA Exports as share of GDP Exports to the world spur regional trade Regional trade as share of GDP The most integrated regions also have the lowest MFN tariffs and lowest costs of trading…

8. For fastest growing countries, revenues from tariffs declined in importance with integration with global economy Tariff revenue, applied tariff and export share in GDP, average for HP16* Exports / GDP Tariff Revenue / total tax revenue applied tariff (tariff revenue / imports) Source: IMF *) Exclude Cambodia and Taiwan due to missing data.

9. Collection efficiency of VAT tends to rise with development…and openness Source: Aizenman and Jinjarak (2005)

10. Methods to estimate revenue effect tend to overestimate losses • Modeling framework • CGE best because allows estimate of trade diversion, secondary effects, and effects on income. • But does not account for dynamic changes and is insufficiently detailed. • Tariff data and exemptions: • Frequently data are out-dated. • Using statutory rates to calculate tariff revenue losses will strongly overstate the impact of liberalization because exemptions are common. • Some African countries collect less than 50% of their statutory tariffs. • VAT and excise revenue: • Most studies do not account for increases in VAT and excise taxes from trade reform. • Trade liberalization increases revenues from VAT and excise duties at the same time as tariffs are lost. • Trade diversion: • Replacing imports from MFN-tariff partners with tax free EU imports can reduce tariff revenue more than the share of current revenue from EU imports. Assumptions on elasticity of substitution will have a critical impact on revenue estimates. • Choice of Reform Scenario: • Liberalization towards the EU is likely to coincide with additional regional integration, so analyzing the impact of free trade solely with the EU may understate the revenue losses.

11. ...and estimates of revenue losses from an EPA vary widely…

12. …because they use different methods and data

13. Ways assumptions affect results -- a thought experiment with Ethiopia Karingi et al., Hammouda Munalula et al. Projections based on ongoing research at the International Trade Department of the World Bank

14. The real world case of tariff reform in Mauritius

15. The real world case of tariff reform in Mauritius

16. The real world case of tariff reform in Mauritius

17. The real world case of tariff reform in Mauritius… total revenues rose

18. Policy conclusions 1: Get the trade strategy right to promote growth • Negotiate for a phased and sequenced trade reform that: • promotes regional integration first, • cuts distorting tariff peaks on an MFN basis to secure efficiency gains, • and only later phases-in preferential cuts to EU firms • Move competitiveness and export-led growth strategies to the center of growth strategies. • Get incentives right – in tariff, tax, and investment policies – to promote exports • Address high costs of services through regulated liberalization • Adopt reforms to trade-related institutions that facilitate and promote trade

19. Policy conclusions 2: Adopt reforms that modernize the tax system integrated into the competitiveness strategy • Broaden the tax base for “difficult to collect taxes” • Simplification: fewer rates, less exemptions • increase size of formal relative to informal sector. • Improving revenue collection • customs reform embedded in a trade facilitation strategy can increase efficiency of collection and stimulate higher imports and exports • Invest in administrative reform of tax authority to improve compliance

20. References and Further Readings Brenton, Paul “Preferences for Africa: How Much are They Worth? World Bank Trade Note (www.worldbank.org/trade/trade notes) Brenton, Paul, Mombert Hoppe, and Richard Newfarmer “EPAs and Development in the New GobalEconomy” Draft June 2007. Karingi et al.(2005): Economic and Welfare Impacts of the EU-Africa Economic Partnership Agreements Busse and Grossmann (2004): Assessing the Impact of ACP/EU Economic Partnership Agreement on West African Countries Hammouda et al. (?): Assessing the consequences of the Economic Partnership Agreement on the Ethiopian Economy Nielsen and Zouhon-Bi (2007): ECOWAS - Fiscal Revenue Implications of the Prospective Economic Partnership Agreement With the EU Munalula et al. (2005): Revenue Impcats of the Economic Partnership Agreement Between the European Union and Eastern and Southern African Countries Khandelwal (2004): COMESA and SADC: Prospects and Challenges for Regional Trade Integration Zgowu and Kweka (2006): Empirical Analysis of Sector-level Trade and Welfare Effects of Reciprocity under an Economic Partnership Agreement with the EU: Evidence from Malawi and Tanzania Milner et al. (2005): Some Simple Analytics of the Trade and Welfare Effects of Economic Partnership Agreements World Bank, Global Economic Prospects 2005: Trade, Regionalism and Development World Bank, 2004.

21. Economic Partnership Agreements:Managing Revenue Implications Richard Newfarmer Special Representative to the WTO and UN World Bank Geneva, Switzerland July 12, 2007