Revenue uncertainty and the choice of tax instrument during the transition in Eastern Europe

The author examines the eroding tax base facing transitional economies by employing a framework that allows risk factors in assessing tax instruments. In an uncertain world, the author asks, which tax instruments should be used? The author examines Eastern Europe's revenue problem, including the implications for public revenue of different causes of uncertainty - and investigates which taxes are"better"at generating revenue. The author defines a"better"tax as one that has greater stability in a risky environment (that is, less variation in generating a target revenue) and has the least adverse impact on the economy (for example, on consumption). The author employs the framework to explain much of the output and revenue fall in transitional economies. The term-or-trade shocks from the collapse of the CMEA trade as well as the rigid but uncertain economic responses in transitional economies are all important factors. The results of the authors modelindicate that import tariffs are more effective than other traditional tax instruments in raising revenue, especially if real revenue is defined in dollar terms (the price anchor). The contraction in domestic output and prices and the devaluation of the real exchange rate needed in the transition are significant reasons that favor imports as a tax base over other revenue sources. To emphasize the transitory nature and reversibility of the policy recommendation, import tariffs should be implemented in the form of a temporary uniform import surcharge. This conclusion seems to hold whether the government formulates tax policy with correct or incorrect expectations. But the choice of revenue target matters. All tax instruments will do almost equally well if the commonly used tax-to-Gross Domestic Product ratio is the target. But it is a misleading measure since the ratio does not reflect the immense erosion of domestic tax bases in the economy and how real revenue in absolute level may actually be decreasing rapidly as a result. The revenue decline and uncertainty can also be viewed as a necessity toward downsizing the large state sector and in redirecting trade away from former nonmarket partners. The results emphasize that restoring revenue should never lead to maintaining subsidies toward nonprofitable state enterprises or other public spending no longer relevant in market system. Doing so will only lead to unreasonably high taxation. No less important is moving assets out of collapsing sectors, privatizing them, and making them productive again.Public Sector Economics&Finance,Banks&Banking Reform,Municipal Financial Management,Environmental Economics&Policies,Economic Theory&Research

External shocks, adjustment policies, and investment : illustrations from a forward-looking CGE model of the Philippines

This paper presents a model that integrates intertemporal and forward-looking behavior in investment and consumption decisions in a multisectoral general equilibrium framework applicable to developing countries. It formulates and uses an infinite-horizon growth model to examine the adjustment, growth, and debt problems of a middle-income country, which the author illustrates using data for the Philippines. The author concludes that the expectation is a key factor. Contrary to the common suggestion that an economy should adjust and contract in response to a permanent import price shock, the behavior suggested in a model with rational expectations in investment decisions is that the opposite can be true. Combined with other policies, tariff reform could rechannel investment and resources toward the more tradable sectors and exports can be emphasized and increased. If domestic resources are also mobilized through increased tax collection, the combined effect will be to reduce or slow the accumulation of foreign debt. In other words, middle-income countries like the Philippines missed a golden opportunity for policy reform in the 1970s and found it harder to implement adjustment policies under less favorable circumstances in the 1980s.Environmental Economics&Policies,Economic Theory&Research,Financial Intermediation,International Terrorism&Counterterrorism,Banks&Banking Reform

Trade liberalization, fiscal adjustment, and exchange rate policy in India

The authors investigate the impact of India's program of economic stabilization and trade liberalization launched in 1991, a year when the country was in the throes of a foreign exchange crisis. The authors address a key policy tradeoff between trade liberalization and fiscal adjustment arising from India's heavy dependence on tariffs for public revenues. They give quantitative expression to how trade liberalization should be coordinated both with fiscal adjustment - that is, a combination of trade-neutral tax increases and expenditure reduction and with a policy of exchange rate changes to restore both internal and external equilibrium. This paper asks: What is the impact of a reduction in the fiscal deficit characteristic of stabilization programs on tax and expenditure levels, on the real exchange rate, and the current account deficit? What is the effect of a significant trade liberalization without additional external financing on macroeconomic variables such as the required degree of fiscal adjustment and change in the real exchange rate, and, at a more disaggregated level, on output levels in different export-oriented and import-substituting sectors of the economy? What would the impact of such trade liberalization look like should substantive external financing become available without the need for domestic fiscal adjustment? The questions are explored using a general equilibrium model of the Indian economy that focuses on the consequences of trade policy reform. Policymakers are, however, also interested in how various import-substituting industries would be adversely affected by trade liberalization and how particular export-oriented industries would gain from it. These objectives are reconciled by the innovative expedient of implementing two models on a common data base: 1) a disaggregated 72-sector (price sensitive) input-output version that makes simplified assumptions regarding certain economywide relationships; and 2) an aggregated 6-sector version that pays attention to those relationships and can suggest what corrections ought to be made to the results of the sectorally disaggregated analysis. The policy questions were answered for the eve of the 1991 economic reform program launched by India's policymakers. Developments in the principal macroeconomic aggregates in the first two years of the liberalization process were then compared with the outcomes of the model and generally found to correspond closely. This finding encouraged an updating of the model for fiscal 1992-93 and its deployment to analyze the consequences of a set of further economic reforms for subsequent years. The authors conclude by suggesting that the approach developed for this paper could provide broad indications of the economywide and sectoral consequences of pursuing the unfinished agenda of reforms facing policymakers not only in India but in other developing countries as well.Payment Systems&Infrastructure,Environmental Economics&Policies,Labor Policies,Economic Theory&Research,Consumption,EnvironmentalEconomics&Policies,Economic Theory&Research,Economic Stabilization,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Consumption

Assessing the odds of achieving the MDGs

How many countries are on target to achieve the Millennium Development Goals by 2015? How many countries are off target, and how far are they from the goals? And what factors are essential for improving the odds that off-target countries can reach the goals? This paper examines these questions and takes a closer look at the diversity of country progress. The authors argue that the answers from the available data are surprisingly hopeful. In particular, two-thirds of developing countries are on target or close to being on target for all the Millennium Development Goals. Among developing countries that are falling short, the average gap of the top half is about 10 percent. For those countries that are on target, or close to it, solid economic growth and good policies and institutions have been the key factors in their success. With improved policies and faster growth, many countries that are close to becoming on target could still achieve the targets in 2015 or soon after.Population Policies,E-Business,Achieving Shared Growth,Primary Education,Country Strategy&Performance

Is Africa's economy at a turning point?

In this paper, Arbache, Go, and Page examine the recent acceleration of growth in Africa. Unlike the past, the performance is now registered broadly across several types of countries-particularly the oil-exporting and resource-intensive countries and, in more recent years, the large- and middle-income economies, as well as coastal and low-income countries. The analysis confirms a trend break in the mid-1990s, identifying a growth acceleration that is due not only to favorable terms of trade and greater aid, but also to better policy. Indeed, the growth diagnostics show that more and more African countries have been able to avoid mistakes with better macropolicy, better governance, and fewer conflicts; as a result, the likelihood of growth decelerations has declined significantly. Nonetheless, the sustainability of that growth is fragile, because economic fundamentals, such as savings, investment, productivity, and export diversification, remain stagnant. The good news in the story is that African economies appear to have learned how to avoid the mistakes that led to the frequent growth collapses between 1975 and 1995. The bad news is that much less is known about the recipes for long-term success in development, such as developing the right institutions and the policies to raise savings and diversify exports, than about how to avoid economic bad times.Economic Conditions and Volatility,Governance Indicators,Achieving Shared Growth,Economic Theory&Research,Emerging Markets

Quantifying the fiscal effects of trade reform

Using a tax model of an open economy, the authors provide a simple but rigorous method for estimating the fiscal impact of trade reform. Both the direction and the magnitude of the fiscal consequences of trade reform depend on the elasticities of substitution and transformation between foreign and domestic goods, so they provide empirical estimates of those elasticities. They also discuss the implications of their analysis for public revenue. In general, they find that it matters what the values of the two elasticities are relative to each other. If only one of the elasticities is low (close to zero), revenue will drop unequivocally as a result of tariff reform, reaching close to the maximum drop whether or not the other elasticity is high. For imports to grow and tariff collection to compensate for the tax cut, the import elasticity has to be high. Because of the balance of trade constraint, however, imports cannot substitute for domestic goods unless supply is able to switch toward exports. Hence, the export transformation elasticity has to be high as well. As substitution possibilities between foreign and domestic goods increase, a tariff reform can theoretically be self-financing. But if the elasticities are less than"large", tax revenue will fall with tariff reduction and further fiscal adjustments will be necessary. The authors provide empirical estimates of the possible range of values for the elasticities of about 60 countries, using various approaches. The elasticties range from 0 to only 3 in most cases - nowhere near the point at which tariff reform can be self-financing.Environmental Economics&Policies,Economic Theory&Research,TF054105-DONOR FUNDED OPERATION ADMINISTRATION FEE INCOME AND EXPENSE ACCOUNT,Trade Policy,Achieving Shared Growth

An Analysis of South Africa's Value Added Tax

In this paper, the authors describe South Africa's value added tax (VAT), showing that (1) the VAT is mildly regressive, and (2) it is an effective source of government revenue, compared with other tax instruments in South Africa. They evaluate the VAT in the context of other distortions in the economy by computing the marginal cost of funds-the effect of raising government revenue by increasing the VAT rates on household welfare. Then they evaluate alternative, revenue-neutral tax systems in which they reduce the VAT and raise income taxes. For the analysis, the authors use a computable general equilibrium (CGE) model with detailed specification of South Africa's tax system. Households are disaggregated into income deciles. They demonstrate that alternative tax structures can benefit low-income households without placing excess burdens on high-income households.

Tax policy to reduce carbon emissions in south Africa

Noting that South Africa may be one of the few African countries that could contribute to mitigating climate change, the authors explore the impact of a carbon tax relative to alternative energy taxes on economic welfare. Using a disaggregate general-equilibrium model of the South African economy, they capture the structural characteristics of the energy sector, linking a supply mix that is heavily skewed toward coal to energy use by different sectors and hence their carbon content. The authors consider a"pure"carbon tax as well as various proxy taxes such as those on energy or energy-intensive sectors like transport and basic metals, all of which achieve the same level of carbon reduction. In general, the more targeted the tax to carbon emissions, the better the welfare results. If a carbon tax is feasible, it will have the least marginal cost of abatement by a substantial amount when compared to alternative tax instruments. If a carbon tax is not feasible, a sales tax on energy inputs is the next best option. Moreover, labor market distortions such as labor market segmentation or unemployment will likely dominate the welfare and equity implications of a carbon tax for South Africa. This being the case, if South Africa were able to remove some of the distortions in the labor market, the cost of carbon taxation would be negligible. In short, the discussion of carbon taxation in South Africa can focus on considerations other than the economic welfare costs, which are likely to be quite low.Environmental Economics&Policies,Transport Economics Policy&Planning,Taxation&Subsidies,Energy Production and Transportation,Environment and Energy Efficiency

Aid, growth, and real exchange rate dynamics

Devarajan, Go, Page, Robinson, and Thierfelder argued that if aid is about the future and recipients are able to plan consumption and investment decisions optimally over time, then the potential problem of an aid-induced appreciation of the real exchange rate (Dutch disease) does not occur. In their paper,"Aid, Growth and Real Exchange Rate Dynamics,"this key result is derived without requiring extreme assumptions or additional productivity story. The economic framework is a standard neoclassical growth model, based on the familiar Salter-Swan characterization of an open economy, with full dynamic savings and investment decisions. It does require that the model is fully dynamic in both savings and investment decisions. An important assumption is that aid should be predictable for intertemporal smoothing to take place. If aid volatility forces recipients to be constrained and myopic, Dutch disease problems become an issue.Economic Theory&Research,Debt Markets,Currencies and Exchange Rates,Emerging Markets,

Wage Subsidy and Labour Market Flexibility in South Africa Delfin S. Go, Marna Kearney, Vijdan Korman, Sherman Robinson and Karen Thierfelder

In this paper, we use a highly disaggregate general equilibrium model to analyse the feasibility of a wage subsidy to unskilled workers in South Africa, isolating and estimating its potential employment effects and fiscal cost. We capture the structural characteristics of the labour market with several labour categories and substitution possibilities, linking the economy-wide results on relative prices, wages, and employment to a micro-simulation model with occupational choice probabilities in order to investigate the poverty and distributional consequences of the policy. The impact of a wage subsidy on employment, poverty, and inequality in South Africa depends greatly on the elasticities of substitution of factors of production, being very minimal if unskilled and skilled labour are complements in production. The desired results are attainable only if there is sufficient flexibility in the labour market. Although the impact in a low case scenario can be improved by supporting policies that relax the skill constraint and increase the production capacity of the economy especially towards labour-intensive sectors, the gains from a wage subsidy are still modest if the labor market remains very rigid.