(Fajgelbaum et al., 2020; 2021 update cited in Fajgelbaum and Khandelwal, 2022) shows that the latter actions essentially fully undid the former.

4.1.3 The Tension between Trade Policy and Fiscal Policy Space Classical trade policy reforms typically do not involve large real resource costs: lowering tariffs or liberalizing services policies does not require financial investments of comparable scale to infrastructure upgrades or fiscal transfers. But many of the policies examined in this paper, or subsumed under the heading of reducing trade costs, do not fall into that framework. Implementing active labor market policies or improving infrastructure and connectivity, as well as many other people-, sector-, and place-oriented policies, involve significant real resource costs. As such, they require the government to have sufficient fiscal space to contemplate responsibly financing the chosen policy measures. This issue is all the more salient at the present time, when necessary fiscal support measures, as well as activity-based reductions in tax takes, due to the COVID-19 pandemic, have reduced fiscal space for countries at all income levels.

In high income countries, and some middle-income countries, the question of financing public spending has little if any connection to trade policy, because trade taxes are not a significant source of government revenue.<sup>6</sup> In terms of averages, the proportion is 6.4% in lower-middle income countries, 3% in upper middle-income countries, and 0% for high income countries (unavailable as an average for low-income countries). There are many countries, however, where the connection is much tighter. Although data availability is only partial, the World Development Indicators record eight low and middle-income countries where the proportion of trade taxes in government revenue is 20% or higher, and 35 where it is 10% or higher. The largest proportion is 37%, in Somalia. So for a significant number of countries, there can be a tension between liberalizing trade by lowering effective tax rates— which tends in turn to lower tax revenues—and the ability to put in place policies that manage the reallocation effects of that liberalization—which requires additional tax revenue. Can this tension between trade policy reform and the need for revenue be resolved, and if so, how?

One approach is a broader shift in policy away from a reliance on trade taxes, towards alternative tax bases (typically income, corporate, and consumption). In theory, governments can implement a trade policy reform and still maintain their revenue if it is accompanied by a more comprehensive domestic tax reform over the long term.

In reality, however, many countries have found such moves difficult to implement effectively over a long period. Evidence for a sample of 60 countries across all income levels for the period 1980-1999 found that globalization, including trade openness, led to a major decline in revenue from ‘easy to collect’ taxes including tariffs, whereas revenue from ‘hard to collect’ taxes (value-added and income) increased, although at a smaller rate. There is, however, substantial heterogeneity across countries, with countries characterized by a low institutional quality being more likely to see their net revenue decline (Aizenman and Jinjarak 2009). In addition, firms are more difficult to tax in a globalized world, as they are internationally mobile and can shift their profits to lower-tax jurisdictions. A similar logic applies to top income earners. Consequently, corporate tax rates and personal income tax rates for the top percentile declined in 65 countries over the period 1980-2007, whereas the median income tax rate rose, both of which have been attributed to rising globalization (Egger et al. 2019). This is

> 6 “Trade taxes” is defined by the World Development Indicators as follows: “Taxes on international trade include import duties, export duties, profits of export or import monopolies, exchange profits, and exchange taxes.” As such, it does not include value added taxes levied on imported goods.

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