Optimal indirect tax design in an open economy
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Optimal indirect tax design in an open economy Yoshitomo Ogawa1 · Nobuhiro Hosoe2
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract Given that tariffs continue to serve as a primary source of government revenue in many countries, we analyze the optimal indirect tax problem, consisting of commodity taxes and tariffs, under a revenue constraint. This study shows that the optimal commodity tax structure follows the Ramsey rule regardless of whether a country is small or large, which implies that the same optimal commodity tax rules are applied across a range of situations. We also show that the optimal tariffs are not zero, but negative, even in the small country case, which implies stronger support for the World Bank’s recommendation of tariff reductions for a country facing a revenue constraint. In addition, this study analyzes the optimal commodity taxation when tariffs cannot be fully adjusted. Numerical examples demonstrate some of our major findings and the magnitude of the welfare gains by these optimizations for a few countries. Keywords Commodity tax · Tariff · Revenue constraint · Terms-of-trade effect JEL Classification F11 · F13 · H21
1 Introduction The reconciliation of the trade-offs between efficiency losses from indirect tax imposition and stable tax revenue raising has long been a major real-world policy issue. This is especially difficult to resolve in developing countries, which have weak tax systems and low taxable incomes and thus tend to rely heavily on trade taxes to raise * Yoshitomo Ogawa [email protected] Nobuhiro Hosoe [email protected] 1
School of Economics, Kwansei Gakuin University, 1‑1‑155 Uegahara, Nishinomiya, Hyogo 662‑8501, Japan
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National Graduate Institute for Policy Studies, 7‑22‑1 Roppongi, Minato, Tokyo 106‑8677, Japan
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revenues to meet their fiscal demand.1 Figure 1 shows the clear downward trend in import tariff dependency along with per capita GDP, showing that many countries rely heavily on customs and other import duties for their tax revenue. While being heavily dependent on tariff revenues, developing countries began to use value added taxes (VATs) in the 1990s (Ebrill et al. 2001). Crowe Horwath International (2016) reports that all but six of the 54 countries in Africa levy VAT. Further, according to the International Monetary Fund (2011), VAT revenue has increased over the past two decades, while trade tax revenue has declined in lowincome, lower middle-income, and upper middle-income countries. Nonetheless, import tariffs still constitute a significant proportion of their tax revenues and cannot be fully replaced with domestic taxes, especially in low-income countries. The above-mentioned reality implies that the optimal tax structure of commodity taxes and tariffs ought to be investigated with an explicit consideration of a revenue constraint. However, most previous studies have investigated them separately. The theory of optimal commodity taxation, which was initiate
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