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    Trade and Investment: Tax Aspects

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    Appan Kandala Vasudevachary
    This document discusses various tax aspects related to international trade. It addresses topics such as when trade reform begins in relation to tariff cuts and tariffication, the revenue impact of replacing import quotas with tariffs, how cutting tariffs can potentially raise effective tariff rates and import revenue, India's experience with sequential trade reform that initially raised tariffs before cutting them, the need for compensating domestic tax revenue when trade tax revenue declines from reform, and challenges around using a VAT to replace declining trade tax revenue in developing countries.

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    Trade and Investment: Tax Aspects

    Uploaded by

    Appan Kandala Vasudevachary
    64 views15 pages
    This document discusses various tax aspects related to international trade. It addresses topics such as when trade reform begins in relation to tariff cuts and tariffication, the revenue impact of replacing import quotas with tariffs, how cutting tariffs can potentially raise effective tariff rates and import revenue, India's experience with sequential trade reform that initially raised tariffs before cutting them, the need for compensating domestic tax revenue when trade tax revenue declines from reform, and challenges around using a VAT to replace declining trade tax revenue in developing countries.

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    This document discusses various tax aspects related to international trade. It addresses topics such as when trade reform begins in relation to tariff cuts and tariffication, the revenue impact of replacing import quotas with tariffs, how cutting tariffs can potentially raise effective tariff rates and import revenue, India's experience with sequential trade reform that initially raised tariffs before cutting them, the need for compensating domestic tax revenue when trade tax revenue declines from reform, and challenges around using a VAT to replace declining trade tax revenue in developing countries.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    64 views15 pages

    Trade and Investment: Tax Aspects

    Uploaded by

    Appan Kandala Vasudevachary
    This document discusses various tax aspects related to international trade. It addresses topics such as when trade reform begins in relation to tariff cuts and tariffication, the revenue impact of replacing import quotas with tariffs, how cutting tariffs can potentially raise effective tariff rates and import revenue, India's experience with sequential trade reform that initially raised tariffs before cutting them, the need for compensating domestic tax revenue when trade tax revenue declines from reform, and challenges around using a VAT to replace declining trade tax revenue in developing countries.

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    Trade and Investment: Tax

    Aspects

    When Does Trade Reform Begin?


    Is the starting point of trade reform:
    the date from which tariff cuts begin?
    or the date from which tariffication of non-tariff barriers
    takes place?

    Tariffication raises tariff rates and raises fiscal


    revenue.
    Tariff cuts on the other hand reduce fiscal revenue,
    unless accompanied by a more than compensating
    import volume increase (elastic import demand).
    If tariffication is simultaneous with tariff cuts, the
    overall impact on tax revenue will be the net
    outcome of the two.
    2

    Import Quotas: An Enduring Puzzle


    The widespread use of quotas in place of tariffs for
    import protection carried a massive revenue cost
    which remains unquantified in global terms.
    That irrational policy preference could have been
    the single biggest cause of poverty persistence in
    the developing world.
    Clearly the driver of that policy preference was that
    quotas carry rents and therefore enable corruption
    in a way in which transparent tariffs do not.
    Trade reform which replaces quotas with tariffs
    could actually raise tax revenue - 45 percent of
    imports are still under quotas in Lao PDR (Montes
    2006); 50 percent in Cambodia (Khattry, 2006).
    3

    Cutting Tariffs
    What matters is the effective, not the nominal
    tariff rate. A cut in the nominal tariff rate,
    accompanied by cuts in import exemptions,
    can actually raise the effective tariff, and raise
    import revenue.
    Example of revenue opportunities: In Lao PDR
    import tariff exemptions are estimated at 29 percent
    of total potential customs revenue

    Sequential Reform: India


    Trade reform in India for example is by common
    consent dated to the nineties, over which the
    notoriously high tariff rates were reduced, not to
    the eighties, when large-scale tariffication took
    place.
    That process had very favourable
    revenue consequences, raising the consolidated
    tax to GDP ratio from:
    13.8 percent in FY81 to
    16.1 percent in FY88

    That phase RAISED Indian tariffs sky-high.


    5

    Effective Import Tariff Rate in India


    1970-2005
    1987-88

    Tax/GDP Ratio in India 1970-2005:


    Shortfalls Relative to 1987-88
    1987-88

    1990-91

    The Cut-off Tariff Rate


    The cut-off (average) tariff rate below which
    revenue will fall as a percent of GDP is estimated
    on the basis of contemporary cross-country
    evidence at:
    23.5 percent by Ebrill et al. 1999 (105 countries over
    1980-95)
    38.5 percent by Khattry and Rao 2002 (80 countries
    over 1970-98).

    Historical data for the US and Canada (Rajaraman,


    2006) show that percent customs revenue to GDP
    declined in response to trade tariff reductions over
    the whole tariff rate range, with higher impact below
    tariff rates of 20 and 15 percent respectively.
    8

    Contrary Evidence?
    A recent estimate for a panel of 22 Sub-Saharan
    African nations over 1980-1996 (Agbeyegbe,
    Stotsky and WoldeMariam 2004) concludes that
    trade liberalization is not strongly linked to
    aggregate tax revenue or its components.
    However, the econometric specification used,
    which tests for a relationship between tax
    revenue and tariff collection rates crosssectionally, in levels, is unsuited to the
    conclusion drawn. Trade liberalization is a
    process over time, and therefore needs to be
    modeled as a change, in first differences.
    9

    The Need for Compensating


    Revenue
    The impact on revenue from trade taxes will
    be a function of the import volume response
    to the price imports, which is impacted by both
    tariffs, and the exchange rate, an important
    price that is not necessarily trade-determined.
    In all cases, trade reform must necessarily be
    hyphenated with fiscal reform. Cambodia
    affords an example of this, with a VAT
    introduced in 1999 prior to tariff reduction, and
    well before WTO-tariff binding in 2004.
    10

    Cross-Country Evidence on Revenue


    Compensation for Falling Trade Tax
    Revenue
    Large cross-country studies show that
    revenue compensation was not generally
    successful in the developing world (Keen and
    Baunsgaard, 2005).
    Ebrill et al. 2001, showed that VATs in
    practice have not been found to enhance
    revenue in low-income countries
    11

    Review of Four LDC Cases


    Cambodia and Bangladesh managed to
    compensate for declining trade tax revenue
    during a process of trade tariff reduction with
    VAT revenue, contrary to the general finding for
    low income countries in general.
    In Nepal, trade tax revenue did not fall even over
    a period of declining effective tariffs, because
    import demand was elastic, and rose in
    response to the decline in tariffs.
    12

    Is VAT a Perfect Solution?


    Two caveats with VAT replacement:
    A uniform rate VAT replacement for a differentiatedrate import tariff regime is regressive, and should be
    supplemented by a non-offsetable import tariff on
    luxury consumer goods imports
    In a federal setting, trade tax revenue accrues always
    at the national level. Tariff reform lowers the national
    government share of tax collections, but a VAT, like
    other indirect taxes, is usually levied only
    subnationally. A fully revenue-compensating VAT, if
    levied at subnational level, will further aggravate the
    loss in share of national government in revenue
    collections. Even a dual VAT will not restore the prereform national share
    13

    Tax Incentives to Attract FDI


    Earlier leader-follower patterns of competitive
    tax incentives for MNCs have largely been
    phased out:
    Indirect tax incentives have been flattened out with
    the widespread acceptance of the final destinationbased VAT
    Direct tax incentives have lost their appeal with the
    increasing use of double taxation avoidance
    agreements

    However, the clustering of export processing


    activities in tax-free zones has given a new form
    to competitive tax incentives.
    14

    Type of Export Zone Incentive


    Indirect tax incentives for export processing
    zones are in alignment with accepted
    principles of taxation (no tax exporting)
    Direct tax incentives for export processing
    zones disrupt the level playing field and may
    be violative of WTO norms

    15

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