- Reint Gropp, Liam Ebrill, and Janet Stotsky
- Published Date:
- July 1999
The association between trade liberalization and economic growth underscores the importance of ensuring that fiscal considerations do not constrain the pace of trade reform. This study has examined the effect of trade liberalization on government revenue. The strategy has been to determine the revenue implications of trade reform in practice by taking three complementary approaches: a comparative analysis of reforms in selected countries, a simple examination of trends in a broad range of countries, and econometric analysis.
The results suggest some observations and policy conclusions:
- Current levels of protection would suggest that many countries could liberalize further without adverse consequences for trade tax revenue even in the near term. In addition, the evidence from the comparative analysis indicates that scope may exist to tailor the pattern of trade liberalization to avoid adverse revenue consequences. Moreover, over the longer term the link between trade liberalization and more rapid economic growth will further bolster revenue for a given level of tariffs.
- Even though some countries have been able to achieve significant trade liberalization by tailoring that liberalization to minimize the revenue consequences, more substantial trade reform might have occurred had maintaining revenue not been a consideration. Accordingly, implementing comprehensive reform of the domestic tax system from the outset of the liberalization process is a priority. An additional reason for stressing the urgency of reforms to bolster domestic taxes is that such reforms have long gestation periods.
- Precisely because trade liberalization can be associated with revenue increases even in cases where trade restrictions are initially high, it can be misleading to interpret an increase in the ratio of trade tax revenue to GDP as evidence of a negative orientation toward trade reform. This is especially true in Africa, which started out with the highest levels of trade tax dependence.
- Genuine trade liberalization must nevertheless eventually result in reduced trade tax revenue and hence will raise difficult fiscal issues if appropriate steps have not been taken to strengthen the domestic tax system. Indeed, some countries have encountered setbacks on the path of trade liberalization because of the revenue consequences. Alternatively, if the revenue impact of trade liberalization is not offset by enhanced revenue performance of the domestic tax structure, the ability of governments to meet essential expenditure needs could be compromised.
- A reformed tax system not only will help generate revenue but also will work to improve resource allocation, potentially contributing to higher rates of sustainable growth.
- It is clear that successful trade liberalization is greatly facilitated by sound supporting macro-economic policies, and in particular appropriate exchange rate policies.
- The interpretation of the trade orientation of small, open economies can be complicated, given that in some circumstances the economic impact of some tariff and domestic tax structures can be broadly similar.
In sum, the main policy conclusion is that trade liberalization would be greatly facilitated by mutually reinforcing combinations of trade reform, domestic tax reform, and sound macroeconomic policies.