Description:
A revenue-neutral switch from trade
taxes to domestic consumption taxes is fraught with
implementation challenges in countries with a large informal
sector. It is shown for a sample of low-income countries
over 25 years that they have had a mixed record of
offsetting reductions in trade tax revenue. The paper then
analyzes the specific case of Nepal, using a unique data set
compiled from unpublished customs records of imports,
tariffs and all other taxes levied at the border. It
estimates changes to revenue and domestic production
associated with two sets of reforms: i) proportional tariff
cuts coordinated with a strictly enforced value-added tax;
and ii) proposed tariff cuts under a regional free trade
agreement. It is shown that a revenue-neutral tax reform is
conditional on the effectiveness with which domestic taxes
are enforced. Furthermore, loss of revenue as a result of
intra-regional free trade can be minimized through judicious
use of Sensitive Lists that still cover substantially all
the trade as required by Article XXIV of the GATT.