**Poli^zy, Research, and External Affairs**

# **Public Economics**

WPS 504 This paper -a product of the Public Economics Division, Country Economies Department -is part of a larger effort in PRE to develop techniques to help policymakers in developing countries identify the implications of different tax reforrn packages for revenue, efficiency, and equity. Copies of the paper are available free from the Wnrld Bank, 1 1 8 11 Strcet NW, Washington DC20-433. Please contact Ann Bhalla, room N 10-059, extension 37699 (46 pages, including tables).

While general principles can guide the design of the overall contours of a tax reform package, models for tax policy analysis can complement analysts' judgments in important and replicable ways. Dahl and Mlitra show their usefulness with three examples.

They use a tax policy model fer Bangladesh to show how one can analyze the revenue and incidence effects of a tax reform proposal of the kind that arises in country economic work. For each sector of the economy, the model is asked: how much must an ad valorem excise tax be raised in that sector to getnerate an additional one percent of _total_ indirect tax revenue? The results show how the burden of tax increases in each sector is distributed across different rural and urban socioeconomic groups and how it affects such variables as the consumer price index and the trade deficit. Since each sector is asked to contribute the sanie amount of revenue, the results can be compared across sectors to show which of them are better candidates for increased taxation in an overall reform package.

The revenue and incidence effects are then combined in a single measure that allows one to rank the sectors by the efficiency-cum-equity cost of raising revenue. Those rankings are used to compare traditional with general-equilibriumbased approaches to incidence analysis, a comparison that underlines the importance of assumptions about the labor market and about substitutability in production in formulating tax policy proposals.

In their second example, Dahl and Mitra use a tax policy model based on data from China to examine the desirability of recommending broad uniformity of tax rates among sectors. Such uniformity may yield acceptable outcomes in market-based economies, but the model shows that losses from uniform taxation can be very significant in a decentralizing socialist economy

- where some production is centrally planned and subject to price controls and some is subject to decentralized decision-making and transacted at market prices.

Their third example, drawn from an ongoing study in India, shows how two models - one sectorally disaggregated but macroeconomically simple, the other macroeconomically richer but sectorally aggregated -can be implemented on a common data base to help study the coordinated reformn of tariffs and indirect taxes. The combined models can be used to calculate how much indirect taxes must be increased, after a reduction in tariffs undertaken to promote an outward-oriented development strategy, to produce enough revenue for the govemment to meet its expenditures without changing the current account deficit.

Finally, Dahl and Mitra discuss the costs of constructing general equilibrium models for tax - policy analysis and implications for data requirements and judgments about modeling stritegy. The most effort must be devoted to (I) establishing a consistent data set and (2) calibrat- - ing the model in a way that allows its behavior to be consistent wiLh what good economic analysis would Iead one to cxpect. These costs must be set against the benefits of the modeling approach to tax policy analysis in developing countries.

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