Academic journal article Journal of Economic Cooperation & Development

Determinants of Tax Revenue: Does Liberalization Boost or Decline It?

Academic journal article Journal of Economic Cooperation & Development

Determinants of Tax Revenue: Does Liberalization Boost or Decline It?

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1.Introduction

Trade liberalization is a hotly debated issue in recent years in economies. However, the early classical theorists; David Ricardo and Eli Heckscher have long pointed out the possible gains from trade. They suggest that these gains result from specialization in production due to international trade. After that, the related issues of trade liberalization became focal point of interests for many authors. As Longoni (2009) stated, one of the most widely accepted theories in economics claims that there exists a positive relationship between a higher degree of openness to international trade and economic growth. As a consequence, a trade liberalization reform is largely considered as a growth-enhancing strategy because of its positive effect on the promotion of efficiency, the improvement in international competition and the expansion of the trade volume. Agbeyegbe et al., (2004) specified that trade liberalization has frequently been the centerpiece of an economic development strategy. Trade liberalization often entails a reduction and unification of tariffs and relaxation of quantitative barriers, and may be accompanied by domestic tax reform. Also, Pupongsak (2009) claimed trade liberalization has outstanding advantage which induces most countries to walk toward free trade regime. Globalization is a phenomenon which involves increases in the flows of trade, capital, information and technology, mobility of labor across borders, substantial expansion in world production, and consequently, a rise in world economic welfare. Trade liberalization is normally associated with the reduction, removal and elimination of taxes on goods and services (including tariffs and import duties), and other trade barriers such as quotas on imports, subsidies, and non-tariff barriers to trade. There are many examples which strongly support the notion that openness to international trade brings more benefits to the country, for instance Harrison (1996), Harrison and Hanson (1999), Rodríguez and Rodrik (2000), which suggest the positive association between trade liberalization and economic growth. In addition, World Bank (2002) reported that almost half of the developing countries which have lowered their average tariffs by about 30 percentage points, experienced growth of per capita income by 4 percent in 1990. Thus, over the past few decades, liberalizing the external trade regime has been one of the central and most visible elements of many less developed and developing countries to achieve accelerated economic growth.

Against the advantages a country can achieve from liberalization process, it has been questioned "Whether all countries have benefited from the gains of trade liberalization?" or "Whether countries which rely heavily on tax revenue as a source of government revenue benefit from liberalization?" The relationship between trade liberalization and tax revenue is therefore an issue of great practical importance, since; trade liberalization is mainly thought to be linked to tax revenue through its effect on international trade tax revenue. On one hand, it has been argued that trade liberalization is likely to lead to a considerable decrease in international trade tax revenue through the reduction of tariffs, especially in developing countries. The fiscal drawback is serious if a country is highly dependent on international trade tax. In this way, economists recommend that, in order to mitigate the loss of international trade tax revenue, one strategy is to boost both domestic direct and indirect taxes, mainly increasing revenue from goods and services tax, by implementing domestic tax reform. Leading revenue sources from international trade tax to broad-based domestic taxes, economists believe that the negative impact of trade liberalization can be offset or reduced. As Greenaway and Milner (1993) found that there is a wide range of possible revenue outcomes from trade liberalization, depending on initial conditions, the components of the reform package, the effects of changes in tariff rates, changes in the import base, and changes in the exchange rate. …

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