Abstract
Despite the well-known gains from trade, the effects of trade openness are a priori ambiguous. For this reason it’s important to establish the effects of trade openness on different sources of government revenue for any country opening its borders to trade. This study sought to establish the effects of trade openness on different categories of taxes. A panel data cointegration technique that uses the Fully Modified Ordinally Least Squares and Dynamic Ordinally Least Squares were employed. The data are annual cross country panels of East Africa countries covering the period 1994-2012. The data were obtained from the IMF’s International Finance Statistics, the African Development Bank’s African Economic Outlook and the World Bank’s World Development Indicators. We found that the average tariff rate used as a measure for trade openness positively influences total tax, indirect tax and trade tax while the average tariff rate squared is negative, illustrating a “Laffer effect” for the three tax categories. The relationship between trade openness and direct taxes is found to be insignificant. The policy implication is that governments of EAC countries should asymmetrically implement trade openness policies, particularly lowering the tariff rate to help in improving tax performance.
Highlights
The latter part of the twentieth century has been associated with substantial expansion in trade flows, capital movements as well as mobility of labour across borders
We found that the average tariff rate used as a measure for trade openness positively influences total tax, indirect tax and trade tax while the average tariff rate squared is negative, illustrating a “Laffer effect” for the three tax categories
The results show that the T-bar and the w (T-bar) test statistic of [30] panel unit root test fail to reject the null hypothesis of presence of unit roots at level for the following variables; total tax to GDP ratio, indirect taxes to GDP ratio, direct taxes to GDP ratio, trade taxes to GDP ratio, average tariff rate, share of agriculture to GDP, share of urban population to the total population and trade ratio to GDP
Summary
The latter part of the twentieth century has been associated with substantial expansion in trade flows, capital movements as well as mobility of labour across borders. During the period world trade in goods and services has grown dramatically from about US $6.199 trillion in 1994 to approximately US $26.02 tril-. This reflects a growth rate of 76.1 percent [1]. In the case of EAC countries trade in goods and services increased from about US $4.4 billion in 1994 to approximately US $36.78 billion in 2012. This shows a growth rate of 88.1 percent [1]. The above statistics indicates that for the period, EAC countries trade grew much faster than world trade
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