Economic Partnership Agreements:Economic Partnership Agreements:Managing Revenue Implications Managing Revenue Implications

July 12, 2007

Richard Newfarmer

Special Representative to the WTO and UN

World Bank

Geneva, Switzerland

This presentation was done with Paul Brenton and Erik Von Euxkull, World Bank

Many developing countries have found it difficult to Many developing countries have found it difficult to recover revenues lost from tariff reductionsrecover revenues lost from tariff reductions

High- income countries recover revenues lost from trade High- income countries recover revenues lost from trade liberalization from other sources liberalization from other sources

On average, middle income countries recover 45-60% of lost tariff On average, middle income countries recover 45-60% of lost tariff revenuesrevenues

Least developed countries – on average -- recover less than 30% of Least developed countries – on average -- recover less than 30% of lost tariff revenueslost tariff revenues having a VAT does not guarantee revenue recoveryhaving a VAT does not guarantee revenue recovery LDCs have a small initial base for the “hard to collect” taxes LDCs have a small initial base for the “hard to collect” taxes

and poor collection efficiencyand poor collection efficiency

Source: Baunsgaard and Keen (2005)Source: Baunsgaard and Keen (2005)

…this underscores the importance of integrating revenue concerns into a trade strategy

Strategic considerationsStrategic considerations: The way EPAs affect revenues will : The way EPAs affect revenues will depend on the depth and sequencing of tariff reforms. But the depend on the depth and sequencing of tariff reforms. But the path of tariff reforms should be guided by a strategy to improve path of tariff reforms should be guided by a strategy to improve competitiveness, and only secondarily by revenue competitiveness, and only secondarily by revenue considerations.considerations.

Methodological considerationsMethodological considerations: Measuring prospective losses : Measuring prospective losses depends on assumptions -- and many studies over-estimate depends on assumptions -- and many studies over-estimate losses.losses.

Policy considerationsPolicy considerations: Policies to replace lost revenues should : Policies to replace lost revenues should be part of tax modernization and integrated into a be part of tax modernization and integrated into a competitiveness strategy.competitiveness strategy.

Key MessagesKey Messages

•DesignDesign

Low external tariff barriers Low external tariff barriers

Nonrestrictive rules of originNonrestrictive rules of origin

Wide product coverage with minimal exemptions Wide product coverage with minimal exemptions

Regulated liberalization of servicesRegulated liberalization of services

Facilitating trade at bordersFacilitating trade at borders

Appropriate rulesAppropriate rules

•Implementation: Avoiding paper agreementsImplementation: Avoiding paper agreements

Regional trade agreements that have succeeded in Regional trade agreements that have succeeded in promoting growth and regional integration share several promoting growth and regional integration share several characteristics…characteristics…

…….Open regionalism.Open regionalismSource: World Bank, 2004; Schiff-Winters, 2002

Phase 1 - 2Phase 1 - 2: Eliminate all internal barriers in CU/FTA to promote integration. : Eliminate all internal barriers in CU/FTA to promote integration. Advantages: promotes regional integration, reinforces trade facilitation and Advantages: promotes regional integration, reinforces trade facilitation and

reduction in border crossing delays, revenue losses minimal, provides reduction in border crossing delays, revenue losses minimal, provides attractive, wider investment arenaattractive, wider investment arena

Phase 1 - 2Phase 1 - 2: Bring down MFN peak tariffs to average: Bring down MFN peak tariffs to average Advantages: promotes efficiency, intra-African trade, introduces more Advantages: promotes efficiency, intra-African trade, introduces more

competition, stimulates exports; moves toward EU common tariff on MFN basiscompetition, stimulates exports; moves toward EU common tariff on MFN basis

Phase 2 - 3Phase 2 - 3: Bring down MFN average levels to East Asian levels: Bring down MFN average levels to East Asian levels Advantages: promotes exports by reducing anti-export bias Advantages: promotes exports by reducing anti-export bias

Phase 3Phase 3: Phased elimination of duties on EU products : Phased elimination of duties on EU products Advantages: backloading minimal trade diversion, wider competition, Advantages: backloading minimal trade diversion, wider competition,

Effect on revenues depends on depth, sequencing and pace Effect on revenues depends on depth, sequencing and pace of tariff reformsof tariff reforms

An illustrative pro-development, phased tariff reform could have An illustrative pro-development, phased tariff reform could have three phases of 5 years each…three phases of 5 years each…

ACP can use EPAs to leverage domestic ACP can use EPAs to leverage domestic reforms, beginning with tariff peaksreforms, beginning with tariff peaks

0 5 10 15 20

6 CEMAC

5 ECOWAS

4 ESA

3 CARCOM

2 SADC

1 Pacific

AFTA

NAFTA

Note: EPA Tariffs are import-weighted at the country level, then weighted by GDP at EPA averagesSource: UN TRAINS, accessed through WITS

Average MFN weighted tariffs

High tariffs undermine competitiveness, often High tariffs undermine competitiveness, often protect monopolies, risk trade diversion, and protect monopolies, risk trade diversion, and impede intra-African trade…impede intra-African trade…

Exports to the world spur regional trade Exports to the world spur regional trade

0

2

4

6

8

10

12

14

16

18

10 15 20 25 30 35 40 45 50

Regional trade as share of GDPRegional trade as share of GDP

Exports as share of GDPExports as share of GDP

East Asia

ECA

LAC

SSA

MNASouth

Asia

The most integrated regions also have the lowest MFN tariffs and lowest costs of trading…

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Source: IMF*) Exclude Cambodia and Taiwan due to missing data.

For fastest growing countries, revenues from tariffs declined in For fastest growing countries, revenues from tariffs declined in importance with integration with global economyimportance with integration with global economy

Tariff revenue, applied tariff and export share in GDP, average Tariff revenue, applied tariff and export share in GDP, average for HP16*for HP16*

Tariff Revenue / Tariff Revenue / total tax total tax revenuerevenue

Exports / GDPExports / GDP

applied tariff (tariff revenue / imports)applied tariff (tariff revenue / imports)

Collection efficiency of VAT tends to rise with Collection efficiency of VAT tends to rise with development…and opennessdevelopment…and openness

-6 -4 -2 0 2 4 6 8 10 12 14

effects of a one standard deviation change in explanantory variables

Urbanisation

Real GDP per capita

Trade Openness

Regulation of politicalparticipation

Durability of politicalregime

Agriculture share of GDP

Collection efficiency (% change) of VAT

Source: Aizenman and Jinjarak (2005)

Methods to estimate revenue effect tend to overestimate losses Methods to estimate revenue effect tend to overestimate losses Modeling frameworkModeling framework

CGE best because allows estimate of trade diversion, secondary effects, and effects on income. CGE best because allows estimate of trade diversion, secondary effects, and effects on income. But does not account for dynamic changes and is insufficiently detailed. But does not account for dynamic changes and is insufficiently detailed.

Tariff data and exemptions:Tariff data and exemptions: Frequently data are out-dated.Frequently data are out-dated. Using statutory rates to calculate tariff revenue losses will strongly overstate the impact of Using statutory rates to calculate tariff revenue losses will strongly overstate the impact of

liberalization because exemptions are common. liberalization because exemptions are common. Some African countries collect less than 50% of their statutory tariffs.Some African countries collect less than 50% of their statutory tariffs.

VAT and excise revenue:VAT and excise revenue: Most studies do not account for increases in VAT and excise taxes from trade reform. Most studies do not account for increases in VAT and excise taxes from trade reform. Trade liberalization increases revenues from VAT and excise duties at the same time as tariffs are Trade liberalization increases revenues from VAT and excise duties at the same time as tariffs are

lost. lost. Trade diversion:Trade diversion:

Replacing imports from MFN-tariff partners with tax free EU imports can reduce tariff revenue Replacing imports from MFN-tariff partners with tax free EU imports can reduce tariff revenue more than the share of current revenue from EU imports. Assumptions on elasticity of more than the share of current revenue from EU imports. Assumptions on elasticity of substitution will have a critical impact on revenue estimates. substitution will have a critical impact on revenue estimates.

Choice of Reform Scenario:Choice of Reform Scenario: Liberalization towards the EU is likely to coincide with additional regional integration, so Liberalization towards the EU is likely to coincide with additional regional integration, so

analyzing the impact of free trade solely with the EU may understate the revenue losses.analyzing the impact of free trade solely with the EU may understate the revenue losses.

...and estimates of revenue losses from an EPA vary widely…...and estimates of revenue losses from an EPA vary widely…

Trade Revenue Loss from EPAs in COMESA (% of total revenue)

Khandelwal (2004) 1)

Karingi et al. (2005) 2)

Munalula et al. (2005) 3)

Brenton et. al,Forthcoming 4)

Burundi 6.9 5.2 8.7

Comoros 6.3

Kenya 7.7 4.2 1.3

Madagascar 1.9 0.9 24.0

Malawi 3.3

Mauritius 11.8 6.0 11.8

Rwanda 10.2

Uganda 0.7 0.7 3.5

Zambia 4.0 2.0 1.6

(Tanzania) 1.1 0.8

1) using COMTRADE data and assuming the elimination of all tariffs on all EU imports. values are globally corrected for some current exemptions

2) using data of unreported origin with a SMART/WITS partial equilibrium model3) based on COMTRADE data4) preliminary data from ongoing research project at the World Bank’s International

Trade Department, based on data from national customs authorities and applied tariff, excise and VAT rates (thus correcting for tariff exemptions)

……because they use different methods and databecause they use different methods and data

Ways assumptions affect results -- a thought experiment Ways assumptions affect results -- a thought experiment with Ethiopiawith Ethiopia

tariffs

tariffs, VAT and

excise

-1.5%

-1.4%

-1.3%

-1.2%

-1.1%

-1.0%

-0.9%

-0.8%

-0.7%

-0.6%

-0.5%

-0.4%

-0.3%

-0.2%

-0.1%

0.0%

0.1%

0.2%

literature base scenario base scenario +exemptions

base scenario +exemptions with

high importelasticity

base scenario +exemptions with

high importelasticity, allexemptions

removed underreform scenario

reve

nue

chan

ge /

GD

P

Projections based on ongoing research at the International Trade Department of the World BankProjections based on ongoing research at the International Trade Department of the World Bank

Karingi et Karingi et al., al.,

Hammouda Hammouda

Munalula Munalula et al.et al.

The real world case of tariff reform in Mauritius The real world case of tariff reform in Mauritius

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005

Tariffs collected and exempted on imports (Bill Rupees)

duties collected

duties exempted

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005

Excise duties collected and exempted on imports (Bill Rupees)

duties collected

duties exempted

The real world case of tariff reform in MauritiusThe real world case of tariff reform in Mauritius

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005

VAT collected and exempted on imports (Bill Rupees)

duties collected

duties exempted

The real world case of tariff reform in MauritiusThe real world case of tariff reform in Mauritius

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005 2000 2001 2002 2003 2004 2005 2000 2001 2002 2003 2004 2005

Taxes collected and exempted on imports

tariff duties excise duties VAT

duties collected

duties exempted

The real world case of tariff reform in Mauritius… total The real world case of tariff reform in Mauritius… total revenues rose revenues rose

Policy conclusions 1: Get the trade strategy right to Policy conclusions 1: Get the trade strategy right to promote growthpromote growth

Negotiate for a phased and sequenced trade reform that:Negotiate for a phased and sequenced trade reform that: promotes regional integration first, promotes regional integration first, cuts distorting tariff peaks on an MFN basis to secure efficiency cuts distorting tariff peaks on an MFN basis to secure efficiency

gains, gains, and only later phases-in preferential cuts to EU firms and only later phases-in preferential cuts to EU firms

Move competitiveness and export-led growth strategies to the Move competitiveness and export-led growth strategies to the center of growth strategies. center of growth strategies. Get incentives right – in tariff, tax, and investment policies – to Get incentives right – in tariff, tax, and investment policies – to

promote exportspromote exports Address high costs of services through regulated liberalizationAddress high costs of services through regulated liberalization Adopt reforms to trade-related institutions that facilitate and Adopt reforms to trade-related institutions that facilitate and

promote tradepromote trade

Policy conclusions 2: Adopt reforms that modernize the Policy conclusions 2: Adopt reforms that modernize the tax system integrated into the competitiveness strategytax system integrated into the competitiveness strategy

Broaden the tax base for “difficult to collect taxes”Broaden the tax base for “difficult to collect taxes” Simplification: fewer rates, less exemptions Simplification: fewer rates, less exemptions increase size of formal relative to informal sector.increase size of formal relative to informal sector.

Improving revenue collectionImproving revenue collection customs reform embedded in a trade facilitation strategy can customs reform embedded in a trade facilitation strategy can

increase efficiency of collection and stimulate higher imports increase efficiency of collection and stimulate higher imports and exportsand exports

Invest in administrative reform of tax authority to improve Invest in administrative reform of tax authority to improve compliance compliance

References and Further ReadingsReferences and Further Readings

Brenton, Paul “Preferences for Africa: How Much are They Worth? World Bank Trade Note (Brenton, Paul “Preferences for Africa: How Much are They Worth? World Bank Trade Note (www.worldbank.org/trade/trade notes) notes)

Brenton, Paul, Mombert Hoppe, and Richard Newfarmer “EPAs and Development in the New Brenton, Paul, Mombert Hoppe, and Richard Newfarmer “EPAs and Development in the New GobalEconomy” Draft June 2007. GobalEconomy” Draft June 2007.

Karingi et al.(2005): Economic and Welfare Impacts of the EU-Africa Economic Partnership Karingi et al.(2005): Economic and Welfare Impacts of the EU-Africa Economic Partnership AgreementsAgreements

Busse and Grossmann (2004): Assessing the Impact of ACP/EU Economic Partnership Agreement Busse and Grossmann (2004): Assessing the Impact of ACP/EU Economic Partnership Agreement on West African Countrieson West African Countries

Hammouda et al. (?): Assessing the consequences of the Economic Partnership Agreement on the Hammouda et al. (?): Assessing the consequences of the Economic Partnership Agreement on the Ethiopian EconomyEthiopian Economy

Nielsen and Zouhon-Bi (2007): ECOWAS - Fiscal Revenue Implications of the Prospective Economic Nielsen and Zouhon-Bi (2007): ECOWAS - Fiscal Revenue Implications of the Prospective Economic Partnership Agreement With the EUPartnership Agreement With the EU

Munalula et al. (2005): Revenue Impcats of the Economic Partnership Agreement Between the Munalula et al. (2005): Revenue Impcats of the Economic Partnership Agreement Between the European Union and Eastern and Southern African Countries European Union and Eastern and Southern African Countries

Khandelwal (2004): COMESA and SADC: Prospects and Challenges for Regional Trade IntegrationKhandelwal (2004): COMESA and SADC: Prospects and Challenges for Regional Trade Integration

Zgowu and Kweka (2006): Empirical Analysis of Sector-level Trade and Welfare Effects of Zgowu and Kweka (2006): Empirical Analysis of Sector-level Trade and Welfare Effects of Reciprocity under an Economic Partnership Agreement with the EU: Evidence from Malawi and Reciprocity under an Economic Partnership Agreement with the EU: Evidence from Malawi and TanzaniaTanzania

Milner et al. (2005): Some Simple Analytics of the Trade and Welfare Effects of Economic Milner et al. (2005): Some Simple Analytics of the Trade and Welfare Effects of Economic Partnership AgreementsPartnership Agreements

World Bank, World Bank, Global Economic Prospects 2005: Trade, Regionalism and DevelopmentGlobal Economic Prospects 2005: Trade, Regionalism and Development World Bank, World Bank, 2004.2004.

Economic Partnership Agreements:Economic Partnership Agreements:Managing Revenue Implications Managing Revenue Implications

July 12, 2007

Richard Newfarmer

Special Representative to the WTO and UN

World Bank

Geneva, Switzerland