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Goods and Fiscal Impact

The argument that trade liberalization leads to a more efficient allocation of resources, welfare gains and, possibly, higher growth, is now widely accepted. However, for many developing countries --especially the least developed countries-- the possible negative impact of a freer trade regime on government revenues and expenditures represents an important obstacle to the lowering of trade taxes or other reforms with equivalent outcome, such as revamping of the customs administration. 

The importance of trade taxes in budgetary revenues of developing countries is well understood and documented. According to a recent IMF survey of 36 least developed countries (mostly which in Africa), for a sample,  trade taxes on average still account for 5 percent of GDP, or approximately one-third of total tax revenues (Abed, 1998, Tables 13-15).  This is in sharp contrast with developed economies for which trade taxes represent a negligible fraction of total tax revenues and have been declining steadily over the past two decades (Ebrill, 1999, Fig. 1). 

The implications of trade liberalization for government expenditures are less well-understood and documented. It is nevertheless true that, unlike a simple reduction of tariff rates, the implementation of many broadly-defined trade reforms, such as the overhaul of customs administration or compliance with the WTO obligation, require heavy budgetary outlays. In a recent study based on World Bank project experience, for example, Finger and Schuler (1999) estimate that compliance with WTO obligations in the areas of the technical, sanitary and phytosanitary standards and intellectual property rights alone can cost some of the least developed economies an entire year's development budget. These costs are associated with the purchase of equipment, training of people, establishment of systems of checks and balances, etc. 

Despite any possible negative impact of trade reform on government revenues and/or expenditures, it is clear that such reforms are needed and must be undertaken if countries are to obtain the static and dynamic benefits associated with reform, which are often several times greater than their immediate costs. What is needed is for trade reforms to be carefully designed, sequenced and embedded in a larger reform package designed simultaneously to boost domestic taxes.

The IMF studies quoted above address the latter point. Ebrill's (op. cit.) paper in particular, examines how countries have balanced these various constraints in practice and suggests a set of best practices for domestic tax reform which would over time offset revenue losses from reductions in trade taxes. 

Further Readings and  links:

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