Tax revenue and trade reform

Trade liberalization and increased openness of the economies hold the prospect of substantial improvements in growth and welfare. But reaping the full economic benefits from trade reform can pose challenges. One of these is coping with potential reductions in government's revenue from tariffs. While the standard prescription for dealing with this is simple in theory - replace lower tariffs by higher domestic consumption taxes - experience shows that many low income countries did not recover lost trade tax revenues following trade reform. Middle and, especially, high income countries are much less reliant on trade taxes and are generally better equipped to offset any revenue loss from trade liberalization by raising domestic taxation. The author reviews the evidence in a broad group of countries and extracts a few general lessons for successful revenue recovery, stressing in particular the importance of design of the domestic consumption tax, political commitment and forethought and administrative capacity building.