ABSTRACT
In many African countries, actual government revenues differ substantially from the amounts implied by multiplication of tax rates with the presumptive tax base. Estimates of this ‘missing revenue’ are almost invariably large enough to be of macroeconomic interest. Following a review of attempts to measure tax evasion, McLaren (1996) characterizes the extent of tax evasion in general in many LDCs as ‘staggering’. The studies reviewed by McLaren suggest that the value of taxes avoided is often close to the value of actual collections for major taxes. With respect to trade policy, avoidance of taxes at the border is often combined with a complex patchwork of legal exemptions. Tsikata (1999) and Pritchett and Sethi (1994) find actual tariff revenues at levels between 44 per cent and 87 per cent of the amounts implied by published tariff rates and estimated import volumes for selected developing economies in Africa and elsewhere. In addition, Pritchett and Sethi find a significant positive relationship between the importance of exemptions and posted tariff rates. Their simulations reveal that reductions in peak tariff rates would likely have minimal revenue effects. These two studies relied on official imports data, so focus is on legal exemptions. Fisman and Wei (2004) examine bilateral trade data between Hong Kong
and China in an attempt to identify both legal exemptions and smuggling. They report an elasticity of evasion with respect to the tariff rate of approximately three. According to their findings, tariff rate declines, particularly for highly taxed items, would result in substantial increases in revenues. They conclude that there are widespread practices of under-reporting and mislabelling from highly to lightly taxed product categories. Given the magnitude of the issue, the study of exemptions and tax evasion
has received considerable attention in the public finance literature. Sandmo (2004) provides a general review of the theory of evasion. Burgess and Stern (1993) review the public finance literature with a specific focus on developing countries. They delve into, among other items, the perennial problem of the application of high rates to relatively small bases with attendant strong incentives for evasion. In more recent work, McLaren (1998) develops a
model where evasion incentives drive the optimal tax pattern. McLaren’s model is consistent with the well-documented tendency for poorer countries, with weak tax administrations, to focus revenue raising efforts on a few relatively easy to administer choke points within the economy, while more advanced economies tend to employ more broad-based revenue raising approaches (see, for example, Tanzi and Zee 2000). Bliss (1992) develops a model that explicitly recognizes the limited availability of tax handles in poor economies and the concomitant important role that taxes levied at the border often play in these economies. While public finance economists highlight the importance of border taxes
in financing activities of the state for poor countries, trade economists frequently tout the benefits of openness for growth prospects.1 The work of Fisman and Wei (2004) and Pritchett and Sethi (1994) indicate that these views are not necessarily in conflict in light of the fiscal realities present in many developing countries. Given the ubiquity of tariff exemptions and evasion, it is possible that revenue neutrality can be maintained despite reductions in tariffs through accompanying reductions in the volume of official exemptions and the empirically observed tendency for rate reductions to reduce incentives to evade. Nevertheless, the degree of disconnect, particularly in analyses of poor
countries, between the role of revenue in the analysis of border policy and the role of the border in revenue analysis is striking. For example, even though trade taxes provide significant revenue to poor countries, analyses of the implications of global trade liberalization for developing countries under the auspices of the World Trade Organization (WTO) rarely contain more than a cursory discussion of revenue issues.2 Furthermore, even though evasion and exemptions are known to be widespread, they are rarely accounted for explicitly in empirical trade policy analyses for developing countries. So, while computable general equilibrium (CGE) models are widely recognized to have been influential in the formulation of trade policies for developing countries over the past two decades, relatively few trade policy applications of a CGE model specifically account for evasion or exemptions. In the context of official exemptions and revenue considerations, it is
important to emphasize that some official exemptions are applied for specific and potentially justifiable reasons. In particular, rationale exists for policies, such as exemptions or rebates, which allow exporters to operate at world market prices for intermediates and investment goods. This is especially true when critical factors of production are internationally mobile, such as in the case of textiles and wearing apparel. Some work in the trade literature has focused on these cases. For example, Bach et al. (1996) model exemption of imported textiles later exported as wearing apparel. Ianchovichina (2005) considers whether these exemptions/duty drawbacks are really worth the administrative effort. She concludes, using China as a case study, that the wisdom of these schemes depends upon initial conditions and objectives. They may or may not be good policy.
