WORLD TRADE
ORGANIZATIONTN/MA/W/18/Add.2
11 April 2003
(03-2001)
Negotiating Group on Market Access Original:  English
MARKET ACCESS FOR NON-AGRICULTURAL PRODUCTS
Revenue Implications of Trade Liberalization
Communication from the United States
Addendum
The following communication, dated 10 April 2003, has been received from the Permanent
Mission of the United States.
_______________
Introduction
1. The United States is pleased to transmit this paper on the revenue implications of trade
liberalization in order to help clarify the nature an d scope of this issue.  The International Monetary
Fund (IMF) has done extensive work in this area th at the Negotiating Group may also find helpful as
it considers modalities for addressing tariffs on non-agricultural goods.  Several countries have made
far-reaching modalities proposals for non-agricultural market access that would substantially reduce
tariffs and in some cases eliminate all tariffs over time.  Substantial action on tariffs would have
significant economic benefits.  The World Bank estimates that the elimination of tariffs would resultin developing country income gains of $500 billion and lift more than 300 million people out of
poverty by 2015.  Three-quarters of this gain would come as a result of developing countries
eliminating their own trade barriers.
1
2. A number of developing countries have raised concerns about the revenue implications oftrade liberalization during the discussion of modalities in the Negotiating Group on Non-Agricultural
Market Access (NAMA).  For many developing count ries, tariffs have been an important source of
government revenue, and they argue that the elimination of tariffs could have serious consequences
for their fiscal stability.  While the reduction of high tariffs may initially increase revenue as imports
grow, aggressive trade liberalization must eventually result in reduced tariff revenue.  Many of themodalities proposals recognize this and allow developing countries sufficient time to reform their
domestic tax regimes in order to take best advantage of the benefits of free trade by proposing long
implementation periods, in some instances through 2015.
3. The purpose of this paper is to share information on the scope of the tariff revenue issue,
highlight tariff revenue trends in the context of ongoing programs of fiscal and tax reform, and note
some of the programs available to advise and assist developing countries in adjusting to the revenue
implications of tariff reduction.
                                                     
1 World Bank, Global Economic Prospects (2002).TN/MA/W/18/Add.2
Page 2
Overview
4. Trade liberalization, when accompanied by sound macroeconomic and fiscal policies,
including reform of domestic tax regimes, provides a significant opportunity for developing countries
to stimulate growth and reduce poverty.  The IMF has emphasized the importance of implementingand sequencing comprehensive reform of the domestic tax system from the outset of the trade
liberalization process.  Tariff regimes are neither an equitable nor economically efficient means for
developing countries to raise revenues, since tariffs tend to distort resource allocation and shift the tax
burden to the poorest segments of the economy.  For example, the highest tariffs in both developing
countries and developed countries are often concentrated on consumer goods (such as apparel) and
agricultural goods.  In tandem with the direct benefits of tariff reduction and elimination, replacement
of tariffs by efficient tax systems would reap significant additional developmental benefits.
5. Import duties are gradually becoming less important as a source of government revenue for
most developing countries.  On average, import duties accounted for about 15% of total government
revenue in 2000/01 for those developing countries listed in the IMF’s Government Financial Statistics
Yearbook (GFSY), down from 18% in 1991/92.2  This trend reflects the efforts of developing
countries to reduce tariffs and to reform their syst ems for collecting revenue.  The major exception is
the group of African least-developed countries, where dependence on import duties remains
significant and has actually grown over the past decade.
6. The capacity to adjust to the revenue implications of substantial reduction (and eventual
elimination) of tariffs is likely to vary from country to country, and from region to region:
• Many developing countries are much less dependent on tariff revenue as a source of government
revenue and should have less difficulty adjusting to the revenue implications of significant tariffreduction and elimination.  With the proliferation of free trade agreements in all regions, many
governments are already facing the revenue issue and are responding positively by eliminatingtariffs and improving taxes.  Most developing countries in Latin America, the Middle East, and
Europe already rely primarily on other revenue sources.  Asian countries, which in many cases are
more reliant on import duties, have already demonstrated a capacity to expand revenue through
non-trade taxes such as value-added taxes, other taxes on goods and services, and income taxes.
• Those countries that may need the most advice and assistance in adjusting to the revenue impact
of tariff reduction and elimination over the medium-term appear to be limited to very specificgroups – many least-developed countries (LDC), some additional Sub-Saharan African countries,
and some island countries in the Caribbean and Pacifica.  Even among these groups, there are a
number of countries that have already substantially reduced their dependence on import duties.
• Many developing countries are already in the process of implementing ambitious fiscal reform
programs to address their fiscal problems.  The revenue effects of trade liberalization can be
mitigated by building on the domestic tax reform s that are already underway, with the advice and
assistance of the international financial institutions.  A survey of economic literature on public
finance reveals that fiscal policy can play a fundamental role in affecting the long-run growth
performance of countries.
• For those countries that need assistance, the international financial institutions, particularly the
IMF and World Bank, can provide advice and assistance for countries willing to undertake tax
and trade reform efforts in the context of sound economic programs.  Of key importance, the IMF
has opened or will open regional centers where assistance may be most critical – Pacifica, the
                                                     
2 IMF, Government Finance Statistics Yearbook, 2001 and 2002 editions.TN/MA/W/18/Add.2
Page 3
Caribbean, East Africa, and (in the near-term) West Africa. The World Bank offers programs to
provide substantial financial support for tax reform in those countries that ask for such help.
• In many instances, tariff reduction may not necessarily have adverse revenue consequences.  A
number of studies have found that reducing high tariffs may actually increase government
revenues by stimulating substantial growth in trade and GDP.  Furthermore, the IMF has foundthat revenue is more likely to be positively affected by trade reform when the initial trade regime
is highly restrictive, i.e., with protectionist tariffs, quantitative restrictions, and other protectionist
non-tariff barriers.
• Virtually all developing countries already have income tax systems in place, and most developing
countries have value-added taxes (VATs), including almost half of the least developed countries.For developing countries as a group, there generally appears to be an inverse relationship between
a country's dependence on a value-added tax (VAT) for revenue and its dependence on importduties.  This suggests that there may be substantial capacity to shift from import duties to other
taxes, even among the least developed countries.
• Well-designed and properly administered tax systems represent more efficient and equitable
mechanisms for raising revenues than import duties.  The IMF has outlined a number “best
practices” for implementing comprehensive tax and tariff reforms.  The best tax systems are thosethat cause a minimum of distortion in the allocation of resources, are equitable, and are relatively
easy to administer.  The shift from import duties to other sources of revenue will not only help
developing countries generate sufficient revenue more equitably, but will improve resource
allocation and reinforce their growth prospects.
Role of Import Duties in Government Revenue
7. The capacity to adjust to the revenue implications of the reduction and elimination of tariffs is
likely to vary from country to country and from region to region.  Each developing country needs to
have an accurate picture of the extent to which it is (or is not) dependent on tariff revenue forgovernment revenue.  In making this assessment, it is important to distinguish between “import
duties” – which would be reduced and then eliminated – and “other taxes collected at the border,”
such as excise taxes and the value-added tax (VAT) on imports – which will not be reduced by tariff
proposals.
8. The table below summarizes the importance of import duties as a source of government
revenue (excluding grants).TN/MA/W/18/Add.2
Page 4
Import Duties as a Share of Government Revenue (by region)3
Region Sub-Group Import Duties as % of
Revenue
1992-93 1999-2001
Least-Developed 29% 34% Africa
Other 26% 22%
Least-Developed 27% 20% Asia
Other 18% 11%
Caribbean 27% 23%
Central America 20% 10%Western Hemisphere
Other 8% 6%
Middle East 12% 8%
Europe 7% 4%
Developing Countries 18% 15%
9. Many developing countries may not have much difficulty adjusting to the revenue
implications of tariff reduction and eventual elimination.  Most developing countries in Latin
America, the Middle East , and Europe  already rely primarily on other revenue sources.  For these
countries, import duties now account for 10% or less of government revenue. Several of these
countries are currently in the accession process.  In many instances, countries in these regions havealready undertaken substantial reforms of their domestic tax regimes. Central America in particular
has undergone a substantial adjustment in the past decade, with the share of import duties to total
revenue dropping from 20% to 10%.  Countries in th is group could adjust to the loss of import duties
from tariff elimination, particularly given a long transition period through 2015.
10. While tariffs play a more important role in many Asian countries (accounting for about 10%
to 20% of government revenue), these countries have already demonstrated a capacity to expand
revenue through non-trade taxes such as income taxes, value-added taxes, and other taxes on goods
and services.  Many of these developing countries are already in the process of implementing fiscal
reform programs (including tax reform) to address fiscal problems.  In addition, for many of these
countries, the real growth in non-trade tax revenue during the past decade significantly exceeded their
current level of duty collections, thus demonstrating a capacity to adjust revenue collections in thefuture.  These countries have an opportunity to design their fiscal programs to reduce dependence on
import duties and expand other more efficient and equitable sources of revenue.
11. A transition period through 2015 should allow these countries sufficient time to adjust to the
revenue implications of tariff elimination.  A number of countries in the region are already becomingless dependent on import duties.
• Pakistan has already undergone a significant adjustment in its tax system and is now less reliant
on import duties for government revenue.  Import duties only accounted for 8% of totalgovernment revenue in 2002, down from 29% in 1992.
• Similarly in Malaysia, import duties only accounted for 6% of total government revenue in 2001,
down from 11% as recently as 1997.
                                                     
3 This summary is based on statistics on 107 developing countries in the IMF’s Government Finance Statistics
Yearbook (GFSY), supplemented by information from r ecent Article IV consultations.  The GFSY does not
cover all developing countries, including several Sub-Saharan African least developed countries.TN/MA/W/18/Add.2
Page 5
• India’s reliance on import duties has fallen from 25% of government revenue in 1991 to 19% in
2000.  Furthermore. the Kelkar Report, which wa s commissioned by India's Ministry of Finance
and released at the end of December 2002, has called for a major overhaul of India's tax system.4
The net effect of the Kelkar recommendations would be to further reduce India's dependence on
import duties as a source of revenue.
12. The revenue implications of trade liberalization are most significant for those countries where
import duties account for more than 20% of government revenue.  Most of these countries fall into
very specific groups – the least-developed countries (LDC), some Sub-Saharan African countries , and
some island countries in the Caribbean and Pacifica .  For many of these countries, current import
duties exceed (sometimes significantly) even the nom inal growth in non-trade tax collections over the
last 5-10 years.
13. Even among these groups, however, there are a number of countries that have already
substantially reduced their dependence on import duties.  Among Sub-Saharan LDCs, Burundi,
Zambia, and Tanzania rely on import duties for about 10-16% of their government revenue.
Furthermore, their collections of non-trade tax revenue have grown significantly in recent years, and
they appear to have the capacity to absorb the re venue impact of tariff elimination over a reasonable
transition period.  Although not members of the WT O, Asian LDCs such as Bhutan, Myanmar, and
Nepal also seem to have the capacity to replace import revenues because of manageable import duty
to revenue ratios.  A number of non-LDC African countries also have relatively low or moderate
import duty to revenue ratios, including Botswana, Republic of Congo, Kenya, Nigeria, South Africa,
and Zimbabwe.  Among the Caribbean countries, Barbados, Jamaica, Trinidad and Tobago, andGrenada are not heavily reliant on import duties.
14. Underscoring the change that is already taking place, 49 of the 108 developing countries
surveyed have already reduced their dependence on import duties by more than 30 percent over the
past 5-10 years.  Well over half have reduced their dependence on import duties by more than 20percent.
Tax Reform
15. Well-designed and properly administered tax systems represent more efficient and equitable
mechanisms for raising revenues than import duties and can complement growth strategies.  An IMF
staff paper entitled Fiscal Policy and Long-run Growth systematically reviewed the existing economic
literature on the relationship between the growth of countries’ economies and various public financeinstruments (including tax policy) and concluded that fiscal policy could play a fundamental role in
affecting the long-run growth performance of countries.
5   Instruments of public finance that can
enhance economic growth include the adoption of policies to improve the neutrality of taxation,
promote human capital accumulation, and lessen income inequality.  The IMF has found, for example,that a properly designed and administered value-added tax retains production efficiency.  “Since it is
levied on consumption and not on intermediate transactions between firms…, a VAT does not distort
the prices that producers face in buying and sellin g from one another.  Accordingly the tax has the
desirable feature of not violating production efficiency…”
6  The two features necessary to ensure that
a VAT is only a tax on consumption are (1) at each stage, net tax must be payable only on thedifference between sales and purchases, and (2) there must be no breaks in the VAT chain.
7  B y
contrast, import duties are highly distortive because they are not uniform, discriminate between
                                                     
4 “Consultation Paper by Task Force on Direct Taxes under Chairmanship of Dr. Vijay Kelkar,” presented to
India’s Ministry of Finance, November 2002.
5 Tanzi and Zee, Fiscal Policy and Long-run Growth, IMF Staff Papers, 1997.
6 Ebrill, Keen, Bodin, and Summers, The Modern VAT, IMF 2001, p 15.
7 Ebrill, Keen, Bodin, and Summers, The Modern VAT, IMF 2001, p 16.TN/MA/W/18/Add.2
Page 6
imported and domestic goods, shift the tax burden to the poorest, and undermine efficient resource
allocation in an economy.
16. The IMF has outlined a number “best practices” for implementing comprehensive tax and
tariff reforms.8  The best tax systems are those that cause a minimum of distortion in the allocation of
resources, are equitable, and are relatively easy to administer.  In practice, comprehensive tax and
tariff policy reforms typically include most of the following:
• A broad-based consumption tax, such as a value-added tax (VAT), should be introduced or
strengthened.  Such taxes should be applied equally to imports and domestic production,
preferably with a single rate, minimal exemptions, and a threshold to exclude smaller enterprises
from taxation.  These taxes may have the greatest potential to replace tariffs as a source of
revenue and would envision a continuing role for customs services.
• The income tax system should be simplified.  The corporate income tax should be levied at on
moderate rate, tax incentives should be avoided, and depreciation allowances should be uniform
across sectors.   The personal income tax should be characterized by only a few brackets and a
moderate top marginal rate, limited personal exemptions and deductions, and extensive use of
final withholding.
• Taxes on international trade should play a minima l role.  Import tariffs should have a low average
rate and a limited dispersion of rates.
• These reforms could be complemented by the introduction of a simplified tax regime for small
business and the informal sector.
• Non-tax revenue, such as surpluses from state enterprises and profits from central bank
operations, should decline.
• Reforms of tax and customs administrations should include modernization of systems and
procedures.  Simplification of tariff and tax systems is a prerequisite for administrative reforms.
17. Virtually all developing countries already have income tax systems in place, and many
developing countries have VATs, including almost half of the least developed countries.  An IMF
publication entitled The Modern VAT provides detailed information on the VAT.9  For developing
countries as a group, there generally appears to be an inverse relationship between a country'sdependence on a VAT for revenue and its dependence on import duties.  This suggests that there may
be substantial capacity to shift from import duties to other taxes, even among the least developedcountries.
Advice and Assistance
18. The international financial institutions, particularly the IMF and World Bank, can provide
advice and assistance for countries willing to undertake tax and trade reform efforts in the context of
sound economic programs.  Such reforms will not only help developing countries generate sufficient
revenue more equitably, but will improve resource allocation and reinforce their growth prospects.
19. The IMF is already providing substantial advice and assistance to many developing countries
undertaking fiscal and tax reforms.  IMF mechanisms for providing advice and/or assistance include
                                                     
8 Ebrill, Stotsky, and Gropp, Revenue Implications of  Trade Liberalization, IMF Occasional Paper 180, 1999.
9 Ebrill, Keen, Bodin, and Summers, The Modern VAT, IMF 2001.TN/MA/W/18/Add.2
Page 7
its regular programs, Article IV consultations, technical assistance, staff missions, and its regional
centers.  Many developing countries are already in the process of implementing ambitious fiscal
reform programs (including tax reform) to address fiscal issues.  The IMF’s Fiscal Affairs Department
provides about 30% of the total technical assistance delivered by the IMF.  The IMF estimates that its
fiscal technical assistance amounts to more than 100 effective person years per year.10
20. In addition, the IMF established regional center s in East Africa (AFRITAC) in October 2002,
the Caribbean (CARTAC) in October 2001, and Pacifica  (1993) that can assist countries with these
revenue issues.  The IMF plans to open a similar regional center in West Africa.  These centers are
strategically placed to help those countries that must undergo the most substantial fiscal reforms,
which in most cases coincides with the countries that are most dependent on tariff revenues.  The
centers will give priority to improving the capacit y of governments to raise revenue, strengthen their
institutional framework for tax policy and revenue administration, and manage public resources more
efficiently.  A key focus is adjustment to the revenue implications of trade liberalization.  CARTAC
(just opened in 2001) has already undertaken substantial tax reform work for Barbados, Guyana, and
the Bahamas and is advising on the preparation of a road map for tax reform in each member country
within an agreed sub-regional framework.
21. Other international financial institutions such as the World Bank and the Inter-American
Development Bank are actively involved in fiscal/t ax reform efforts.  For example, the World Bank
has provided extensive advice and lending operations focusing on both tax policy and tax
administration reform.  Of about 120 lending operations in the 1990s with components seeking tostrengthen some aspect of the tax system, 43 projects with an outlay of $3.8 billion had major tax or
customs administration reform components and 40 ot hers had important components addressing other
aspects of tax systems.
11  The availability of assistance from these institutions is demand-driven, i.e.,
they are willing to provide advice and assistance on fiscal/tax reform issues, but the developing
country must ask for it so that it can be mainstreamed in the country assistance strategy.   Structurallending by the Bank in this area can provide a bridge while the borrower reforms its tax policies and
improves its tax administration, and the Bank has consistently found that the economic/financial
return on these operations easily offsets the costs of the loans.  In addition, several Members have
bilateral programs that can assist developing countries in implementing tax and fiscal reforms.  We
would invite members that are providing bilateral assistance on revenue issues to share their activities
and experiences with the Negotiating Group.
Revenue Impact of Tariff Reduction
22. The revenue implications of tariff reduction may differ from the revenue implications of tariff
elimination.  A number of studies have found that reducing high tariffs may actually increase
government revenues in the short-term by stimula ting substantial growth in trade and GDP.  The IMF
has found that revenue is more likely to be positively affected by trade reform when the initial trade
regime is highly restrictive, i.e., with protectionist tariffs, quantitative restrictions, and other
protectionist non-tariff barriers.  Those countries with the most restrictive trade regimes tend to be the
same countries that are most dependent on import duties for government revenue.
23. The IMF’s Occasional Paper entitled Revenue Implications of Trade Liberalization, published
in 1999, provides the most detailed analysis of the nexus between trade and revenue.12  While this
analysis did not envision a duty-free world, many of its key conclusions are enlightening with respect
to the revenue concerns associated with significant trade liberalization.  Its major conclusions were:
                                                     
10 IMf, Annual Report 2002
11 Barone, Das-Gupta, De Wulf, and Hansson, “Reforming Tax Systems: The World Bank Record in the
1990’s,” 1999.
12 Ebrill, Stotsky, and Gropp, Revenue Implications of  Trade Liberalization, IMF Occasional Paper 180, 1999.TN/MA/W/18/Add.2
Page 8
• Current levels of protection suggest that many countries could liberalize further without adverse
consequences for trade tax revenue even in the near term.  Evidence from comparative analysis
indicates that it is possible to tailor the pattern of trade liberalization to avoid adverse revenue
consequences.  Over the longer term, the link between trade liberalization and more rapid
economic growth will further bolster revenue for a given level of tariffs.
• Implementing comprehensive reform of the domestic tax system from the outset of the
liberalization process is a priority, given the long gestation for such reforms.
• Trade liberalization, at least initially, can result in revenue increases, particularly when the initial
trade regime is highly restrictive, i.e., with protectionist tariffs, quantitative restrictions, and other
protectionist non-tariff barriers.
24. Genuine trade liberalization must nevertheless eventually result in reduced trade tax revenue
and hence will raise difficult fiscal issues if appropriate steps have not been taken to strengthen the
domestic tax system.  A reformed tax system will not only help generate revenue, but also will work
to improve resource allocation, potentially contributing to higher rates of sustainable growth.  The
U.S. delegation can provide further information and contacts for those countries that wish to explore
the benefits of a reformed tax system.
__________