Taxation structures of small states with special reference to revenue implications following trade liberalisation

Abstract

Recent years have seen the progressive liberalisation of world trade as a consequence of unilateral liberalisation by countries; proliferation of regional trade arrangement; and agreements reached under the auspices of the World Trade Organisation. As a result the trade preferences once afforded to Small States have been eroded and will continue to decrease in the coming years. These developments are of particular interest to Small States since these states tend to rely more on international trade taxes for tax revenue purposes. In fact, several Small States do not have income tax. Instead they obtain most of their revenue from tariffs. This study has two main aims. First, it looks at the taxation structures of Small States and analyses to what extent they differ from those of larger countries. Then it looks at the possible tax revenue implication on Small States following the trade liberalisation process and the eventual move towards income and consumption based taxes. The dependence of Small States on trade tax is shown by the fact that expressed as a percentage of total tax revenue, international trade tax stands at 36.3 per cent in Small States. This study shows that there is a substantial difference in the taxation structures of Small States, differing accordingly to their geographical location, with Small States in Asia and Africa being the most dependent on tariffs. Another interesting finding is the relationship between the level of development and taxation structures. It has been determined that those Small States that score high on the HDI tend to collect most of their tax revenue from taxes on income, profit and capital gain, while Small States having a low HDI tend to raise most of their tax revenue from taxes on international trade. Empirical analysis, using Two Stage Least Square, also confirmed this relation between the level of development and international trade tax. Indeed the analysis shows that the level of trade tax collected is negatively related to the level of development and to the size of the country while it is positively related to economic openness. Finally, this study discusses the effects of the reduction in tariffs on tax revenue in Small States. It goes to establish that although the magnitude of the effects of the dismantling of tariffs on revenue in Small States is difficult to quantified, much will depend on the circumstances within which trade liberalisation takes place and on how the shift towards income and consumption based taxes is managed. Indeed, the adoption of VAT is seen as an important step towards the reforming of taxation structures in Small States, although less developed economies face additional challenges mainly due to their lack of resources and their economic structure.