Tariff-Tax Reforms in Large Economies

IMF Working Papers, May 1, 2012

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Studies tariff-tax reforms in a calibrated two-region global New Keynesian model composed of a developing and an advanced region.
Focuses on how tariff reductions interact with consumption taxes under alternative reform designs (revenue-neutral reforms and "point-for-point" reforms) and with nominal rigidities.

In the baseline calibration, a revenue-neutral reform that lowers tariffs in developing countries can reduce domestic welfare.
The welfare loss in developing countries arises because the increase in welfare from higher output is dominated by welfare losses stemming from the deterioration of the terms of trade.
The same revenue-neutral reform increases output and welfare in the advanced countries and in the world as a whole.
The highlighted effects differ from prior literature that typically uses a small open economy framework and therefore do not capture these two-region interactions.
Nominal rigidities have important implications for adjustment dynamics:
- In the case of a "point-for-point" reform, price stickiness implies that the international dynamics of output is reversed compared to a revenue-neutral reform.

Tariff reductions in large developing economies may not unambiguously raise domestic welfare if implemented as revenue-neutral reforms; terms-of-trade effects can outweigh output gains.
Assessments of tariff-tax reforms for large economies should account for general equilibrium international terms-of-trade effects rather than rely on small open economy intuition.
The presence of nominal rigidities and the design of the reform (revenue-neutral versus point-for-point) critically affect short- and medium-run adjustment dynamics and cross-border spillovers.

Model: Calibrated two-region global New Keynesian model (developing region and advanced region).
Subjects: Consumption, Consumption taxes, International trade, Labor, Labor supply, National accounts, Tariffs, Taxes, Terms of trade.
Keywords: Consumption, consumption tax, Consumption taxes, expenditure switching, Global, imperfect competition, Labor supply, liberalization effort, open economy macroeconomics, point-for-point reform, reform fall, tariff rate, tariff reduction, Tariff-tax reform, Tariffs, Terms of trade, terms-of-trade effect, trade liberalization, trade negotiations, WP.