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The Effect of Trade Liberalization on Taxation and Government Revenue THE EFFECT OF TRADE LIBERALIZATION ON TAXATION AND GOVERNMENT REVENUE by SUPARERK PUPONGSAK A thesis submitted to the University of Birmingham for the degree of Doctor of Philosophy Department of Economics College of Social Sciences The University of Birmingham September 2009 University of Birmingham Research Archive e-theses repository This unpublished thesis/dissertation is copyright of the author and/or third parties. The intellectual property rights of the author or third parties in respect of this work are as defined by The Copyright Designs and Patents Act 1988 or as modified by any successor legislation. Any use made of information contained in this thesis/dissertation must be in accordance with that legislation and must be properly acknowledged. Further distribution or reproduction in any format is prohibited without the permission of the copyright holder. Abstract This thesis investigates the trade and revenue impact of trade liberalization. The purpose is to address the following issues: to examine the effect of trade liberalization on the volume of imports and exports, taxation, and its association with the enhancement of the performance of overall tax system. An empirical analysis is conducted by, first, adding liberalization factors to the import and export demand functions to assess their impact on imports and exports. The results indicate that, for Thailand, trade liberalization does not lead to the deterioration in the trade balance. Instead, it helps improve export performance. However, trade deficit may still occur due to a high income elasticity of demand for imports, rooted from its import structure. Although trade liberalization is not found to be associated with the problem of trade imbalance, the fiscal imbalance may still persist due to the mechanism of tariff reduction. In order to deal with the fiscal problem, the government needs to implement domestic tax reform. The consequence of reform may vary since liberalization impacts on taxation differ greatly depending on various factors. The study examines its effect on taxation, by applying a tax effort model and employing a two-way fixed effect approach. The results suggest that tax reform in less developed and developing countries, by moving away from trade tax to domestic taxes, may be inapplicable since domestic taxes may also severely suffer from liberalization. However, tax reform is still necessary and thus the study applies the concept of tax buoyancy and elasticity to evaluate the ability of Thailand’s tax system to mobilize its revenue after the reform. The results reveal that the tax system as a whole is buoyant and elastic due to the high tax-to-base buoyancy of corporate income tax, especially in the post-AFTA period. The main findings from empirical studies have important policy implications for tax strategies of Thailand and other developing countries. Acknowledgements I am very grateful to my principal supervisor, Professor Somnath Sen, who provided not only invaluable comments and constructive suggestions on my work, but also constant encouragement during the course of this research. In particular, I am extremely grateful for his effort to read through different drafts of this thesis. I would also like to express my gratitude to my second supervisor, Mr. Nicholas Horsewood for his very helpful comments and constructive suggestions on econometric analysis. What I learned from him is beyond econometric techniques, particularly his attitude to research. My indebtedness also goes to Professor Anindya Banerjee and Professor Indrajit Ray who provided invaluable assistance and support. I am also grateful to all members of secretarial team in the Department of Economics of The University of Birmingham, including Ms Julie W Tomkinson, Ms Emma Steadman, Ms Jackie Gough, Ms Wendy Rose and Ms Maureen Hyde, for all their help. I am also thankful to Mr. Akarapong Unthong for providing his statistical software and guidance, which is so valuable for this thesis. Many thanks to my dear friends and colleagues Visanu Vongsinsirikul, Duangkamol Prompitak, Puyang Sun, Jiale Cen, Vimal Thakoor and Fanfan He, for having always been kind, patient and supportive. My deepest gratitude, however, goes to my parents, my sister, my little tiger and my little tiger’s parents for the tremendous encouragement and support that they have offered during my study in the United Kingdom. Finally, financial support from the Revenue Department, Ministry of Finance, Royal Thai Government is gratefully acknowledged. Contents Chapter 1. Introduction 1 1.1.General Introduction and Motivation 2 1.2.Various Issues Related to Trade Liberalization 11 1.2.1.Trade Liberalization and Structural Adjustment 11 1.2.2.Trade Liberalization, Economic Growth, and National Welfare 13 1.2.3.Trade Liberalization and “Contractionary” Devaluation 17 1.2.4.Trade Liberalization and Poverty Reduction 19 1.2.5.Trade Liberalization and External Shocks 22 1.2.Outline of the Thesis 24 Chapter 2. A Survey of the Theory of Trade Liberalization 30 2.1.Introduction 31 2.2.The Strategy to Offset Revenue Shortfall from The loss of Foreign Trade Tax by Using Domestic Indirect Tax 32 2.3.The Strategy to Offset Revenue Shortfall from The loss of Foreign Trade Tax by Using Domestic Direct Tax 36 2.4.Summary and Conclusion 50 Chapter 3. Trade Liberalization and Trade Performance in Thailand 53 3.1.Introduction 54 3.2.Thailand’s Import and Export and Trade Policies 57 3.3.General Review: Empirical Studies on the Relationship between Trade Liberalization, Imports, and Exports 68 3.4.The Model and Methodology 74 3.4.1.The Model Specification and Equations 75 3.4.2.The Data 79 3.4.3.The Methodology 82 3.5.Empirical Analysis 90 3.5.1.Import Demand 90 3.5.1.1.The Analysis of the Long-run Total Import Demand 90 3.5.2.Export Demand 106 3.5.2.1.The Analysis of the Long-run Total Export Demand 106 3.5.3.Comparison 119 3.6.Conclusion 126 Chapter 4. Estimating the Impact of Trade Liberalization on Tax Revenue 129 4.1.Introduction 130 4.2.General Review: Theoretical and Empirical Background on the Relationship between Trade Liberalization, International Trade Tax, and Domestic Taxes 134 4.2.1.The Failure of Revenue Source Substitution 134 4.2.2.Characteristics of Developing and Less Developed Countries: Self Constraints 136 4.2.3.The Effect of Trade Liberalization on Tax Revenues 142 4.3.The Basic Model of Tax Effort 153 4.4.The Extended Model, Data, and Empirical Methodology 156 4.5.Empirical Results 163 4.6.Conclusions 177 Appendix 4A: Summary of Previous Studies in Tax Effort 181 Appendix 4B: Panel Unit Root Test 182 Chapter 5. The Impact of Trade Liberalization on Revenue Mobilization and Tax Performance 183 5.1.Introduction 184 5.2.The Reform of Taxation in Developing Countries 187 5.2.1.The Choice between Income and Consumption Taxes: Theoretical Considerations 188 5.2.2.Overview of Fiscal Profile 195 5.2.3.Summary of Fiscal Policies 214 5.2.3.1.Thailand’s Tax Reform 214 5.2.3.2.Malaysia’s Tax Reform 219 5.2.3.3.Indonesia’s Tax Reform 220 5.2.3.4.Philippines’s Tax Reform 222 5.3.General Review: Buoyancy and Elasticity of Tax Revenue and Empirical works on Revenue Productivity of the Tax System 224 5.4.Framework of the Study 232 5.4.1.Methodology and the Regression Models 232 5.4.2.Variables, Data and Sources 241 5.5.Empirical Results 243 5.6.Conclusion 259 Appendix 5A: Tests for Stationarity 264 Appendix 5B: Regression Results – Tax Buoyancy and Tax Elasticity 265 Appendix 5C: Regression Results – The Decomposition of Tax Buoyancy 272 Appendix 5D: Cointegration Test – Tax Buoyancy and Tax Elasticity 279 Chapter 6. General Conclusion 289 6.1.Summary and Conclusions 290 6.1.1.Qualifications 290 6.1.2.The Main Findings 291 6.2.Clarifications and Conclusions Derived from the Econometrics 305 6.2.1.The Impact of Trade Liberalization on the Tariff Structure of Thailand 305 6.2.2.The Composition of Thailand GDP 309 6.2.3.The Problem Associated With Quantifying the Impact of Trade Liberalization on Tax Revenues 313 6.2.4.The Issue of Income Distribution and Profitability of Corporations in Thailand 315 6.3.Policy Implications 316 6.4.Option for Further Study 318 Bibliography 320 Lists of Figures Figure 2.1. Partial Equilibrium of Coordinated Tax-tariff Reform 34 Figure 3.1. Trade as a Percentage of GDP 57 Figure 3.2. Trade in Goods and Services as a Percentage of GDP 58 Figure 3.3. Share of Agricultural and Manufactures Exports in Merchandise Exports 59 Figure 3.4. Share of Agricultural and Manufactures Imports in Merchandise Imports 60 Figure 3.5. Imports and Exports of Goods and Services 61 Figure 3.6. Trends in Average Tariff Rates 63 Figure 3.7. Thailand’s Import Share of GDP and Thailand’s Average Tariff Rate 64 Figure 3.8. Thailand’s Export Share of GDP and World’s Average Tariff Rate 64 Figure 4.1. Laffer Curve 144 Figure 5.1. Budgetary Revenues and Expenditures in Thailand, 1972 to 2006 196 Figure 5.2. Budgetary Revenues and Expenditures in Indonesia, 1972 to 2006 196 Figure 5.3. Budgetary Revenues and Expenditures in Malaysia, 1972 to 2006 197 Figure 5.4. Budgetary Revenues and Expenditures in the Philippines, 1972 to 2006 197 Figure 5.5. Share of Tax and Non-Tax Revenue in Total Revenue (US Dollar; Millions); Thailand, 1972-2006 198 Figure 5.6. Share of Tax and Non-Tax Revenue in Total Revenue (US Dollar; Millions); Indonesia, 1972-2006 198 Figure 5.7. Share of Tax and Non-Tax Revenue in Total Revenue (US Dollar; Millions); Malaysia, 1972-2006 199 Figure 5.8.
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