A new discussion paper by Lanre Kassim, KDPE 1605, June 2016
Trade taxes are a major source of government revenue in Sub-Saharan Africa as these taxes are easier to administer compared to domestic taxes (See African Trade Policy, 2004). The advent of trade liberalisation, however, leads to a gradual decline in the revenue from trade taxes. If this drop in trade tax revenues is not offset by an increase in domestic tax revenues, then there is an inevitable decline in total tax revenues...
Indeed, this scenario could constrain long run output growth in SSA as governments may not have enough revenue to finance their expenditures in key areas such as education, health and infrastructure. Moreover, if the government borrows to finance its spending, output growth may not be stimulated as the public save in anticipation of future tax increases. This puzzle constitutes a significant concern for many SSA countries as they negotiate further trade reforms in the form of the Economic Partnership Agreements. In this paper, therefore, we investigate the impact of trade liberalisation on total tax revenues across 28 SSA countries from 1981 to 2010.
To the best of our knowledge, Agbeyegbe et al (2004) is the only paper in the literature to empirically examine the effect of trade liberalisation on tax revenue in Sub-Saharan Africa. Other studies in the region have focused on individual countries such as Matlanyane and Harme (2002) in South Africa; Epaphara (2014) in Tanzania and Nwosa et al (2012) in Nigeria. Using the ratio of import duties to the value of imports and trade to GDP ratio as measures of trade liberalisation, Agbeyegbe et al find no relationship between the two measures and the share of total taxes in GDP. In our paper, we adopt the ratio of trade taxes to total trade (that is, average trade tariffs) and a liberalisation dummy variable as measures of trade liberalisation. Also, we adopt panel data models of fixed effects and generalised method of moments for econometric analysis.
The results show that trade liberalisation has increased total tax revenue in Sub-Saharan Africa. This increase in revenue is stimulated by trade reforms such as the replacement of quantitative restrictions with tariffs; the unification of exchange rate which lowers incentives to engage in illegal activities and privatisation of state-owned enterprises which implies maximum profits and better organisation of tax returns thereby increasing income tax revenues and ultimately, total tax revenues. In addition, we find that average trade tariffs has significantly decrease trade and total tax revenue, but increase domestic tax revenue.