The challenge of equitable tariffs

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Offline fatema nusrat chowdhury

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The challenge of equitable tariffs
« on: February 25, 2015, 03:34:50 PM »
There is more to tariffs than meets the eye. This was clearly evident in 18th century mercantilist Britain when Adam Smith, the father of economic science, learnt this by opting to take an assignment as a customs commissioner before becoming the Rector of Glasgow University. While tariffs were an essential source of government revenue in those days, Smith recognised the protective implications of those tariffs. That scenario has not changed to this day, except that there are far too many interlocking issues now than there were in those times. Let me make an attempt here to cover some of the critical ones that impact everyday life and the economy.

A stylised fact of development is that as countries develop, their reliance on tariffs and other import-based taxes decline. The USA and other members of OECD – the developed countries – collect less than 3.0% of their tax revenue from import taxes, compared to Bangladesh’s 40%. Customs administration in those countries is engaged in surveillance and prevention of contraband items from entering the country. Revenue is least of their concerns thoughtrade facilitation is. We still have a long way to go before reaching middle income status, and longer still before tariffs are discarded as a significant source of revenue. Though declining in importance, we are willy-nilly stuck with substantial amounts of import tariffs for the foreseeable future, along with the distortions in business incentives and inequities associated with such taxes. The formidable challenge for policymakers in Bangladesh is to mobilise the maximum revenue with the minimum rates of tariff and minimal distortions in the economy. If past experience is any guide, there appears to be as much pressure to raise certain tariffs as there is to reduce some. The tax authority is left to perform a delicate balancing act – with success not always guaranteed -- because stakeholders are many.

To be sure, stakeholder interests diverge and are often in conflict with each other. Making sense of all these divergent viewpoints while making sure there is enough revenue pouring into the national exchequer is no mean task for the national tax authority – the National Board of Revenue (NBR). Even more important is to make sure that business incentives are not distorted by the structure of import taxes, leaving production and investment on a progressively higher growth trajectory.

The first stakeholder is the NBR, entrusted with the sovereign task of mobilising revenue in order to finance public expenditures. Less revenue means less resources for the government to spend on roads, bridges, health and education. Just like individual budgets, there is a limit to how much government can spend in excess of its revenue income. Foreign aid and domestic borrowing can be relied on to finance some amount of the government’s budget deficit, but not a whole lot without sending the economy on an inflationary spiral. Each year NBR has to prepare an estimate of tax revenues – from domestic activities and external trade -- to finance planned public expenditures. At a time when export taxes are all but gone, imports remain the principal source of tax revenue generation from our external trade. Tariffs and other import taxes and levies (described in economic jargon as para-tariffs) become the instruments of revenue mobilisation. The problem is that tariffs play the dual role of raising revenue on the one hand and providing shelter (protection) to domestic industries on the other. The two roles are complementary only up to a point. Beyond that higher tariffs yield lower revenues by discouraging imports of high tariff items but, because of that, they provide even higher protection. For NBR then, whose legal mandate I believe is to raise revenue (protection being the statutory subject of the Bangladesh Tariff Commission), the strategy would be to search for that optimal tariff rate that yields the highest revenue. That is the ideal scenario though reality is quite different.

Enter the next group of stakeholders – the producers. When it comes to tariffs the interests of two groups of producers diverge: those that produce import competing goods for the domestic market would like to see tariffs on imports as high as possible; those that produce for exports would like to see the opposite. At this point, popular wisdom and economic rationale are at odds with each other. It is popular – and even nationalistic – to talk of protecting domestic industries. High tariffs provide shelter from import competition and raise profitability, allowing local industries to flourish – or, so we believe. In the 1960s, this was described as “infant industry protection” and was considered the only strategy for industrialisation in developing countries. Not any more. After two decades of infant industry protection, the world was littered with geriatric infants who never seemed to grow out of their infancy. In the 1980s, this notion of industry support got discarded. Economic research produced evidence that countries that had more opentrade regimes (less protection) with export orientation experienced much faster rate of industrialisation and economic growth (e.g. S Korea, Hong Kong, Taiwan, Singapore -- Asian Tigers).