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This study explores the effects of replacing income tax with consumption tax in developing countries following trade liberalization. Results show differential poverty impacts and efficiency variations, highlighting the importance of genuine poverty analysis in tax reform strategies.
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Developing country tax replacement in trade liberalization Christian A. EminiTorbjörn G. Jansson
Motivation • Tariff revenues important for nat. budget • Enforcing… requires • QUESTION: Which tax to choose for VarTax? • Options: Income tax vs. Consumption tax
Experimental design Closure: Choice of replacement tax Income tax Consumption tax Unilaterally for RICH:Output taxInput subsidies Multilaterally remove: Import tariffs Export subsidies PovRich0 PovRich1 Shock
Main results • Differential poverty effect of reform • Income tax is GENERALLY* better • Why? * Not in Vietnam, but the difference is very small there
GE-effect of tax choice • Income tax influences allocation less • Income tax is more efficient • Utility generally higher with Income tax replacement • Utility increases in all regions with income tax • Then why was there no general poverty reduction?
Welfare vs. Poverty Analysis • General opinion: Welfare and poverty vary in opposite directions • But it could be misleading to limit analysis only to welfare impacts: • A raise in welfare could lead in poverty worsening! • A fall in welfare could lead in poverty alleviation! ? ?
Welfare vs. Poverty Analysis Drivers of the poverty impacts • Initial distribution around the poverty line • The initial poverty gap (intensity of poverty) • The pattern of consumption shares: with regard to change in prices of most consumed products • Sources of income shares: with regard to change in factor returns • The pattern of initial distortions and the nature of the replacement tax or shock
Concluding Remarks • More efficiency is good for Welfare (and GDP) improvement • But it is not automatically pro-poor • This non triviality verified through tax replacement experiments justifies per se the importance to set a genuine poverty module within the model