Trade Costs and Tax Structure Reform in Developing Countries

Abstract

Developing countries are striving to reform their tax structure so as to reduce their total tax revenue's dependence on international trade tax revenue. The present study has investigated the effect of trade costs on this type of tax structure reform (also referred to as "Tax transition Reform" - TTR) through the trade openness channel in developing countries. It has additionally examined how development aid and economic growth performance alter the effect of trade costs on the TTR process. The analysis has used a set of 124 countries over the period 1996–2019, and the two-step system generalized method of moments estimator. It shows that over the full sample, higher overall trade costs, in particular higher nontariff costs discourage the pursuance of the TTR process, while nontariff costs exert no significant effect on TTR. In less developed countries, higher overall trade costs (including higher nontariff costs) tend to promote the TTR, while higher tariff costs discourage the pursuance of TTR. Concurrently, in relatively advanced countries, the overall trade costs (including nontariff costs) undermine the TTR process, but higher tariff costs do not influence it. The analysis has also shown that higher trade costs (overall trade costs, tariffs costs, and nontariff costs) undermine the TTR process in countries that enjoy high degrees of openness to international trade. In other words, countries that wish to pursue their TTR process while further opening-up their economies to international trade have to reduce their trade costs. On the other side, high amounts of development aid allow developing countries to strengthen the TTR process in the context of higher trade costs. Finally, a high economic growth performance fosters the TTR process when countries face higher nontariff costs, while the effect of tariff costs on TTR does not depend on countries' economic growth performance. JEL Classification: O34; F14; F35.