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7 Revenue and Welfare Implications of SAFTA: Partial Equilibrium Analysis INTRODUCTION The trade theory argues that trade liberalisation enhances economic efficiency, promotes growth and helps correct domestic market failures in imperfectly competitive markets. However, these benefits have associated costs, one of which is the loss of trade tax revenue. Trade taxes constitute an important part of government revenue in developing countries. In general, it is found that countries’ reliance on revenues from taxes on international trade is inversely related to their income levels (Baunsgaard and Keen 2005). Given this, tariff loss due to trade liberalisation may be substantial for SAFTA member countries, therefore welfare implications of trade liberalisation become an important issue. Recent research suggests that for developing countries with binding government budget constraints, it is a priority to implement comprehensive reform packages of the domestic tax system to accompany trade liberalisation. Baunsgaard and Keen (2005) use panel data of over 25 years for 111 countries and show that high-income countries in fact recovered the revenues they have lost from other sources from past episodes of trade liberalisation. For middle-income countries, recovery has been in the order of 45–60 cents for each dollar of lost trade tax revenue, with signs of close to full recovery when separately identifying episodes in which trade tax revenues fell. Troublingly, however, revenue recovery has been extremely weak in low-income countries (most of which depend on trade tax revenues): they have recovered, at best, no more than about 30% of each lost dollar. The view that loss of tariff revenue may have adverse implications for tariff-dependent developing countries, as it may lead to lower government expenditure as the entire loss is not recovered by taxes, has been supported by many 1 SMART rests on the Armington assumptions. studies in the literature (Emran and Stiglitz 2005, Munk 2005, Atolia 2006). It is although argued about the loss of revenue to the government may not be fully recovered through alternative source, very few studies have actually estimated the extent of revenue loss to countries under SAFTA. In this chapter, we use the partial equilibrium model to estimate the impact of zero tariff regime on the revenue and welfare of SAFTA member countries. REVENUE, WELFARE AND TRADE EFFECTS: METHODOLOGY Revenue, Welfare and Trade Effects have been estimated using UNCTAD/World Bank SMART model. SMART is a partial equilibrium model simulating the impact of a tariff change on trade flows, tariff revenue and consumer welfare for a single market. 1 It focuses on one importing market and its exporting partners and assesses the impact of a tariff change scenario by estimating new values for a set of variables. The theoretical framework of SMART on the export side assumes that, for a given good, different countries compete to supply a given home market. The focus of the simulation exercise is on the composition and volume of imports into that market. Export supply of a given good by a given country supplier is assumed to be related to the price that it fetches in the export market. The degree of responsiveness of the supply of export to changes in the export price is given by the export supply elasticity. SMART assumes infinite export supply elasticity – that is, the export supply curves are flat and the world prices of each variety are exogenously given. This is often called the price-taker assumption. SMART can also operate with finite elasticity – upward sloping export supply functions – which entails a price effect in addition to the quantity effect.
R EVENUE AND WELFARE IMPLICATIONS OF SAFTA: PARTIAL EQUILIBRIUM ANALYSIS 55 To model the behaviour of the consumer, SMART relies on the Armington assumption. In particular, the adopted modelling approach is based on the assumption of imperfect substitution between different import sources (different varieties). That is, goods (defined at the HS 6-digit level) imported from different countries, although similar, are imperfect substitutes. In the SMART modelling framework, a change in trade policy (tariff liberalisation) affects not only the price index/ level of the composite good but also the relative prices of the different varieties. SMART reports the results of any trade policy shock on a number of variables, including tariff revenue, consumer surplus, and welfare. Tariff revenue change on a given import flow is computed simply as the final advalorem tariff multiplied by the final import value minus the initial advalorem tariff multiplied by the initial import value. Using SMART simulations, an attempt has been made to estimate revenue effect of tariff reduction by 100%. Revenue effect of 100% tariff reduction are also cross checked by multiplying simple and weighted average tariff with total import value of the country. Welfare and trade creation effect of 100% tariff reduction has also been estimated by SMART modelling. REVENUE, WELFARE AND TRADE EFFECTS: RESULTS Impact on Bangladesh Tables 7.1 and 7.2 indicate bilateral revenue, welfare and trade effects of zero tariffs under SAFTA for Bangladesh. • Revenue losses to Bangladesh are estimated to be about $0.9 billion on the basis of SMART simulation while it is $0.5 billion on the basis of weighted average tariff and 0.23 billion in case of simple average. Maximum revenue loss of $0.88 billion is due to tariff cut by 100% on imports from India (Table 7.1). • There are welfare gains for Bangladesh and other SAARC countries from 100% tariff reduction by Bangladesh. Welfare gains for all seven countries amounts to $0.8 billion and maximum welfare gains are due to tariff cuts by India and Bangladesh (Table 7.2). • 100% tariff reduction by Bangladesh creates trade of approximately $0.27 billion (Table 7.2). Table 7.2 Effect of 100% Tariff Cuts on Welfare and Trade: Bangladesh ($ ‘000) Partner Country Welfare Effect Total Trade Effect India–Bangladesh 766,355 269,669 Bhutan–Bangladesh 0 0 Pakistan–Bangladesh 29,299 6,173 Sri Lanka–Bangladesh 127 3,593 Nepal–Bangladesh 32 133 Total effect 795,813 279,569 Impact on India Tables 7.3 and 7.4 indicate bilateral revenue, welfare and trade effects in case India cuts tariff by 100% for SAFTA member countries. • Revenue losses to India are about $0.12 billion on the basis of SMART simulation while it is also approximately $0.1 billion on the basis of simple and weighted average tariff. Results are quite consistent in both the approaches (Table 7.3). • There are welfare gains for India and other SAFTA member countries from 100% tariff reduction by India. Welfare gains for all seven countries amount to be $0.8 billion (Table 7.4). • In case of 100% tariff reduction by India, trade increased by approximately $0.7 billion (Table 7.4). Table 7.1 Effect of 100% Tariff Cuts on Revenue: Bangladesh ($ ‘000) Partner Country Revenue Effect: Using Revenue Effect Revenue Effect Bangladesh Imports SMART Simulations (using simple average) (using weighted average) India–Bangladesh –887,442 –202,676 –505,603 1,278,712 Bhutan–Bangladesh 0 0 0 0 Pakistan–Bangladesh –25,858 –29,672 –26,098 142,379 Sri Lanka–Bangladesh –1,954 –1,910 –2,094 9,567 Nepal–Bangladesh 0 –28 –7 129 Total effect –915,254 –234,286 –533,802 10
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Preface Our consultations with seni
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viii CONTENTS 7. Revenue and Welfar
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Executive Summary OBJECTIVE This st
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EXECUTIVE SUMMARY xiii Table 1 EAMA
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EXECUTIVE SUMMARY xv India A full S
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Part I BENEFITS FROM TRADE, INVESTM
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APPENDICES
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Appendix 8 Intra SAARC FDI Collabor
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Appendix 11 Table A11.1 On an Emplo
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Appendix 12 Original Commitments/In
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Appendix 14 Table A14.1 Telecommuni
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Appendix 15 REFERENCE PAPER Scope T
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Bibliography Abelson, P. (1996),
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BIBLIOGRAPHY 241 Cuba (2002), Negot
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BIBLIOGRAPHY 243 (2004), Impacts of
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BIBLIOGRAPHY 245 Silva, Patricia an
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BIBLIOGRAPHY 247 (1998), Tourism Se
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