# **1. Introduction**

As many developing and transition countries rely on import tariffs as an important source of revenue,<sup>1</sup> evasion of customs duties has attracted a lot of attention from policy makers. For instance, a report released by the state’s budgetary watchdog, the Audit Chamber, found that the Russian customs service was plagued by corruption which was costing the state billions of dollars annually (Baumgartner, 2001). An investigation by the Supreme Board of Inspection (NIK) in Poland suggested that importers used various methods to artificially lower the value of imported goods, including fake invoices and double invoicing (Polish News Bulletin, 2000). Revenue loss aside, there are other undesirable effects of tariff evasion. It boosts the profitability of well-connected firms at the expense of honest producers and importers. It may hinder the accession process to the World Trade Organization and hurt the image of the country as an attractive location for foreign direct investment.

The purpose of this study is to enhance our understanding of tariff evasion—concealment of dutiable imports by private parties (individuals or private firms). It aims to do so in three ways. First, it documents the existence of tariff evasion in transition countries by demonstrating that in 8 out of 10 Eastern European economies, the discrepancy between the export figures reported by Germany and the import data recorded by the importing economy is systematically related to the tariff level.<sup>2</sup> In this way, it shows the generality of the pattern found for China by Fisman and Wei (2004). It also improves on Fisman and Wei’s work by relying on panel data rather than mostly cross-sectional information. Second, it finds that tariff evasion is more prevalent for differentiated products, as defined by Rauch (1999). This result is intuitive as it is more difficult to accurately assess the price of differentiated products, which means that honest customs officers find it more difficult to detect an invoice stating an incorrect price and corrupt customs officers have a plausible explanation for why they did not detect the problem with the invoice.<sup>3</sup> Third, the study shows that tariff evasion in the case of differentiated product tends to take place by misrepresenting the price of imported goods rather than by undercounting physical quantities or misclassifying products.

> 1 Customs and other import duties accounted for 62% of tax revenue in the Maldives, 55% in Lesotho, 50% in Madagascar,  42% in Bangladesh, 16% in Tajikistan and 10% in Ukraine (2004 figures from the World Bank’s _World Development Indicators_ ).

> 2 Note that while some discrepancy in trade data may be due to lower quality of data recording in Eastern European countries, in the absence of evasion such discrepancy would not be systematically related to the tariff rate.

> 3 An investigation into customs import control launched by the Polish Supreme Board of Inspection showed that the value of imported goods, as included in customs declarations, was often “ridiculously low,” which went unnoticed by customs officers. Importers used various methods to artificially lower the value of imported goods, including fake invoices issued by both foreign suppliers and the importers or double invoicing. In most such cases, according to the NIK report, customs officers either did not want or were unable to question the evident misrepresentation of prices. The verification of customs value of imported goods during customs clearance procedures was in most cases carried out according to the sole discretion of the customs officers on duty (Polish News Bulletin, 2000).

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