Academic journal article Contemporary Economic Policy

The Impact of Tax Regimes on International Trade Patterns

Academic journal article Contemporary Economic Policy

The Impact of Tax Regimes on International Trade Patterns

Article excerpt


This paper investigates the trade impacts of global tax patterns following a dramatic shift to the implementation of consumption taxes over the past 20 years. Consumption taxes, such as value-added taxes (VATs), expect to have a neutral impact on international trade because they refund domestic taxes paid by exporters of domestic production while imposing reciprocal taxes on imports of foreign production; that is, they create a level playing field. The emergence of such taxes may have an impact on global trade patterns, however, to the extent that they replace potentially trade-distorting income taxes, particularly in the presence of asymmetric tax regimes. In investigating the trade neutrality of VATs, we find that VATs positively affect U.S. exports but with differing impacts by sector.

Consumption taxes have grown in attractiveness due to trade liberalization, resource mobility, and economic integration. The World Trade Organization (WTO) allows for border adjustments on indirect taxes to mitigate potential cross-border effects; direct taxes, levied on income or profits, are not border-adjustable under WTO obligations. As income taxes may negatively affect trade activity, a country could remove market distortions by switching to consumption taxes and therefore improve production efficiency. (1) Accordingly, VATs have been adopted rapidly over the past few decades, including by every Organisation for Economic Co-operation and Development (OECD) country-except the United States, and consumption taxes currently affect over 90% of global trade. The impact of VATs on trade patterns, however, has not been extensively investigated using empirical methods.

We link tax policy to empirical trade analysis with direct relevance to two current policy issues in the United States: trade competitiveness and tax reform. The results provide substantive econometric evidence that adopting VATs may have a significant impact on international trade. Section II provides background on VATs as they are in effect around the world. Section III sets up an empirical model for testing. Section IV provides results; Section V discusses the implications of changes in VAT rates on the results; and Section VI offers conclusions.


Currently more than 143 countries have adopted VAT systems, with over 90% of international trade subject to a relevant border adjustment. The United States has been the only OECD country without a VAT since Australia switched its tax regime in 2000. Figure 1 displays a map shaded according to VAT adoption and 2008 VAT rates. While this figure reflects VATs adopted prior to January 2009, the econometric analysis below takes into account the changes in VAT adoption from 1989 through 2008 to estimate the impact on bilateral trade in the presence of asymmetric tax policies. Of the 145 countries in our data set, 86 adopted the policy over that time period, allowing for substantial within-country variation. (2)

Trade implications for tax policy arise in part because international obligations, as well as U.S. bilateral treaties, treat consumption taxes and income taxes very differently. The WTO, for example, allows for export refunds of indirect (consumption) taxes but not direct taxes such as the corporate income tax. (3) A U.S. resident purchasing a good in Europe for consumption in the United States does not have to pay a European consumption tax (the VAT is levied at the point of sale and refunded at the border), but a European resident purchasing a good in the United States subject to a local sales tax must pay the sales tax even if the good will be consumed in Europe. (4) Neither Europeans nor Americans need to pay U.S. VAT on goods purchased and consumed in the United States because it does not exist; both Europeans and Americans must pay the consumption tax on goods purchased and consumed in Europe. (5)

The VAT has emerged as a tax policy of choice for many countries in the context of increasing integration, and recent economic discussion has focused on the relationship among globalization, openness, and tax policy. …

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