Trade liberalization and the challenges of revenue mobilization: can international financial institutions make a difference?

Developing countries are being confronted with severe fiscal challenges in the global economy. Over the last two decades, governments have been accepting significant reductions in trade taxes to support trade liberalization. This is particularly problematic for developing economies because trade taxes have been a key source of government revenues. In this paper, we investigate the conditions under which international financial institutions (IFIs) successfully assist developing countries with recovering the lost revenue from trade liberalization by implementing various domestic tax reforms. We argue that regime type mediates the effectiveness of IFI assistance in developing economies, after trade reforms have been adopted. More specifically, IFIs will be more effective at assisting authoritarian regimes with domestic tax reforms as a substitute for trade taxes than they will be in poor democracies. Democratically elected leaders inadvertently undermine multilateral assistance with tax reforms because they are more susceptible to middle- and upper-class demands for lower taxes in a competitive global economy. In authoritarian regimes, on the other hand, IFIs such as the World Bank and International Monetary Fund tend to be more effective because dictators are likely to experience far fewer political consequences for accepting IFI assistance and implementing tax reform in the global economy than their democratic counterparts.