Globalization affects types of taxes that countries use.

Globalization and Developing Countries—A Shrinking Tax Base? finds that during the globalization process countries shift their tax base from “easy to collect” taxes such as tariffs and seigniorage towards “hard to collect taxes” like VATs and income taxes. Between the 1980s and 1990s, the revenue/GDP ratio of the “easy to collect” taxes for developing countries dropped by 20% in developing countries while the revenue/GDP of the “hard to collect” taxes increased 9%. However, because of the difficulty in implementing these “hard to collect” taxes for developing countries, there was a short-term net drop of 7% in total tax revenue/GDP.

The authors identify several reforms that are integral to globalization: trade liberalization (reducing tariffs, quotas, and other non-tariff trade barriers); financial liberalization (reducing capital controls, and financial repression); and macroeconomic stabilizations (reducing inflation, reducing thereby the financial spread and the cost of borrowing). The authors hypothesize that all of these reforms erode the revenue from “easy to collect” taxes and forces the governments of developing countries to switch to “hard to collect” taxes to minimize their losses. They also hypothesize that in the short-term developing countries will not be as successful at implementing these more difficult taxes as wealthy nations and will short-term losses.

“Easy to collect” taxes include tariffs, inflation tax, and the printing of money and are traditional sources of revenue for developing countries. When the revenue from these taxes drop to globalization , a government must rely on alternative “hard to collect” sources such as Value Added Taxes [VAT], income taxes, and sales taxes. Aizenman and Jinjarak emphasize that this switch is may produce a short-term negative fiscal shock to developing countries, but that it is justified because it promotes long-term growth.

Using data from 86 countries, the authors test their hypotheses about the impact of globalization on the types of taxes utilized by developing nations. The choice of these countries is dictated by data availability over the period 1980-1999. They test the effects of structural and political variables and their globalization factors on the annual revenue collection via VAT, seigniorage, and tariff revenues divided by GDP using Seemingly Unrelated Regression (SUR) analysis. In order to control against the possibility of reverse causality from fiscal adjustment to globalization, the authors lag the variables for institutional quality, political durability, trade openness, and financial integration by one period. Because these explanatory variables are subjective, several alternative estimations for these variables are used to ensure robustness.

1. Globalization: The major finding is that the effects of globalization, measured by trade openness and financial integration, have a even larger impact than the effects of the institutional and political variables combined. Globalization increases VAT collection, and reduces seigniorage and tariff revenue.
2. Urban versus agricultural countries: “Easy to collect” taxes are applied more heavily in a country with larger agricultural share in GDP. “Hard to collect” taxes are more prevalent in urban areas because they are easier to enforce.
3. Institutional quality and political durability: Countries with better institutional quality and more stable politics collect more from “hard to collect” taxes, and less from “easy to collect” taxes.
4. Level of economic development: A higher level of development and income, which is measured by per capita GDP, is associated with higher collection for “hard to collect” taxes and lower for “easy to collect” taxes.

The authors determined that high-income and the middle-income countries managed to more than compensate for the revenue decline of the “easy to collect” taxes, increasing the total tax/GDP. In contrast, low income developing countries experienced sizeable drop in the tax/GDP. Fiscal convergence was also found. The variation of tax revenue/GDP measures across countries declined substantially during 1980s1990s. The cross country variation declined by about 50% for seigniorage, about 30% for tariff, and about 15% for the “hard to collect” taxes. These results are consistent with the notion that improving the performance of the “hard to collect” taxes is more challenging than reducing the use of “easy to collect” sources of revenue.

While the drop in “easy to collect” effective tax rates is more pronounced for high income countries, the greater initial base of “hard to collect” taxes in these countries relative to developing countries implies a net increase in total taxes of 5% in the first group, and a drop of 7% in the second. A one standard deviation increase in financial integration is associated with a decline of the seigniorage revenue/GDP by 0.8%, half of which is compensated by an increase in the VAT revenue/GDP of 0.4 %. A one standard deviation increase in trade openness leads to a drop tariff revenue/GDP by 0.2%. Among the structural factors, a one standard deviation increase in urbanization increases the VAT revenue/GDP by 0.7, the seigniorage revenue/GDP by 2.7%, and reduces the tariff revenue by 0.8%.

Interestingly, most of the variation across the four income groups was in the revenue from “hard to collect taxes”, which was about 7% of GDP for the low income, progressing upward and reaching 15% of GDP in the high income countries. In contrast, there was little variation in the revenue from “easy to collect taxes” across the various groups: it was 5% of GDP for the low income, reaching 7% of GDP for the high income countries. The total tax/GDP mimics the patterns of the “hard to collect” taxes: it was about 14% of GDP for the low income group, progressing upward with GDP/Capita and reaching 27% of GDP for the high income group.

Overall, the record is mixed. Interestingly, the drop in the revenue from “easy taxes” was larger for the higher income groups, in fact the revenue from easy taxes went up for the low income by 5%. Both the high income and the middle income managed to increase the revenue from the “hard taxes” significantly (10% and 37%, respectively) and increasing the total tax/GDP by 5% and 8%, respectively. The increase in revenue from the “hard taxes” was rather timid for the upper and the low income countries (4% and 6%, respectively], less than what was needed to compensate for the drop in the revenue from “easy taxes.” This induced a drop in the total tax revenue of 9% for the upper income countries and 15% for the low income developing countries.