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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
  • 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
  • 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
  • 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
  • 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
  • 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
  • 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 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
  • 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;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”.
tax competition double tax relief and factor movements
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: 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
  • 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
  • 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