Taxation and Trade

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

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 Traded Goods Non-Traded Goods

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

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

Taxation and Trade