Regional integration and commodity tax harmonization
In a closed economy, a commodity tax drives a wedge between the producer price and the consumer price. In open economies, intercountry differences in commodity taxation can induce two additional distortions: (1) Cross-country differences in consumer marginal rates of substitution (which result in an inefficient allocation of world consumption), which arise when countries levy taxes on goods and services consumed within their borders (the destination principle). (2) Cross-country differences in producer marginal rates of transformation (resulting in an inefficient allocation of world production), which arises when countries levy taxes on goods and services produced within their borders (the origins principle). Such distortions can be avoided by harmonizing tax rates, ensuring efficiency regardless of the tax principle adopted. At least, that is the theoretical rationale for international tax harmonization. Regionally such harmonization can be justified, because equalities between marginal rates of substitution and transformation exist between economically integrated countries. Removing barriers to trade and factor movement exposes the allocation of resources more directly to tax rate of differentials. But gains in production and consumption efficiency derived from regional harmonization are not great. Moreover by reducing international distortions, harmonization could increase internal distortions and reduce welfare, if the new tax structure is inefficient and does not meet the country's preferences. Tax rate uniformity does not appear to be the right way to maximize welfare if integrating countries are different. Some flexibility should be maintained. And apart from the misallocation of resources, tax rate diversity can induce strategic behavior. A country's choice of tax rate can be influenced by the choices of others. Countries can race to cut rates to attract foreign consumers or producers -or if they have market power, they can increase taxes on imported goods and decrease them on exports. So, externalities arise: the"usurpation of the tax base"(in the first example) or the"export of the tax burden"(in the second). Competition between countries would then lead to Nash equilibria in the tax-rate-setting game, resulting in a welfare level inferior to that attainable by cooperation. In fact, there is some evidence that revenue effects might be large for small countries, where the tax structure is often used as a protective device. If both harmonization and competition can produce welfare losses, one solution could be coordination measures aimed at reducing exploitation of other member countries through taxation.
|Date of creation:||30 Nov 1997|
|Date of revision:|
|Contact details of provider:|| Postal: 1818 H Street, N.W., Washington, DC 20433|
Phone: (202) 477-1234
Web page: http://www.worldbank.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- FitzGerald, John & Quinn, T. P. & Whelan, Brendan J. & Williams, J. A., 1988. "An Analysis of Cross-Border Shopping," Research Series, Economic and Social Research Institute (ESRI), number GRS137.
- Jacob Frenkel & Assaf Razin & Efraim Sadka, 1991.
"International Taxation in an Integrated World,"
MIT Press Books,
The MIT Press,
edition 1, volume 1, number 0262061430.
- Cnossen, Sijbren, 1990. "The case for tax diversity in the European community," European Economic Review, Elsevier, vol. 34(2-3), pages 471-479, May.
- Roger H. Gordon, 1983. "An Optimal Taxation Approach to Fiscal Federalism," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 567-586.
- Sinn, Hans-Werner, 1990.
"Tax harmonization and tax competition in Europe,"
Munich Reprints in Economics
19846, University of Munich, Department of Economics.
- Smith, Alasdair & Venables, Anthony J., 1988.
"Completing the internal market in the European Community : Some industry simulations,"
European Economic Review,
Elsevier, vol. 32(7), pages 1501-1525, September.
- Smith, Alasdair & Venables, Anthony J, 1988. "Completing the Internal Market in the European Community: Some Industry Simulations," CEPR Discussion Papers 233, C.E.P.R. Discussion Papers.
- Deaton, Angus & Stern, Nicholas, 1986. "Optimally uniform commodity taxes, taste differences and lump-sum grants," Economics Letters, Elsevier, vol. 20(3), pages 263-266.
- Michael Devereux & Mark Pearson, 1990. "Harmonising corporate taxes in Europe," Fiscal Studies, Institute for Fiscal Studies, vol. 11(1), pages 21-35, February.
- Ravi Kanbur & Michael Keen, 1991.
"Jeux Sans Frontieres: Tax Competition and Tax Coordination when Countries Differ in Size,"
819, Queen's University, Department of Economics.
- Kanbur, Ravi & Keen, Michael, 1993. "Jeux Sans Frontieres: Tax Competition and Tax Coordination When Countries Differ in Size," American Economic Review, American Economic Association, vol. 83(4), pages 877-92, September.
- Burgess, Robin & Stern, Nicholas, 1993. "Taxation and Development," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 762-830, June.
- Hans-Werner Sinn, 1990. "Can Direct and Indirect Taxes Be Added for International Comparisons of Competitiveness?," NBER Working Papers 3263, National Bureau of Economic Research, Inc.
- Whalley, John, 1979. "Uniform domestic tax rates, trade distortions and economic integration," Journal of Public Economics, Elsevier, vol. 11(2), pages 213-221, March.
When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:1848. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)
If references are entirely missing, you can add them using this form.