The Impact of the CFTA on Tariffs, Trade Tax and Fiscal Revenue: - - PowerPoint PPT Presentation

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The Impact of the CFTA on Tariffs, Trade Tax and Fiscal Revenue: challenges and solutions.

Financial Support by EU

Impact of the CFTA

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▪ The Continental Free Trade Area (CFTA) will bring together 54 African countries with a combined market of $3.4 billion and over one billion people. ▪ Estimates suggest that the CFTA will result in welfare gains of up to $7bn and increases in the share of intra African trade in total trade by 5% to 10%. ▪ With the implementation of the CFTA there will, however, be adjustment costs. ▪ For governments these adjustment costs relate to lower fiscal revenue from lower trade taxes, and higher expenditure on social safety nets etc. ▪ For the private sector they relate to unemployment, lower wages and obsolescence

• f skills and machinery.

▪ There are also concerns that premature liberalisation could contribute to de- industrialisation.

Managing Adjustment

▪ There are a range well-established trade policy instruments and support measures to deal with such concerns.

• For example, harmful surges in imports can be managed through the temporary

application of safeguard measures (which restrict imports)

• and unfair competition can be addressed through anti-dumping duties.

▪ The challenge of effectively dealing with the fiscal loss is the most pressing at this point in CFTA negotiations, given that several Member States rely on trade taxes for a large part of their tax revenues.

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Focusing in on Fiscal Loss

▪ Estimates of fiscal loss in the CFTA suggest that the initial impact is limited by the current low levels

• f

intra African trade (13.6%) and the exemptions on liberalisation that the Member States are likely to maintain. ▪ Moving past the initial impact, it is expected that total taxes will fall by roughly 0.2%- 0.3%

• f

GDP,

• n

average, because of the CFTA. ▪ For Sub-Saharan Africa, excluding Nigeria, South Africa and Angola, it is expected that tax losses would be between $1.1bn - $1.7bn, on the basis

• f 2015 figures, and $1.15bn - $2.3bn,
• n the basis of 2016 figures.

▪ At the level of Regional Economic Communities (RECs), tariff revenue (not total taxes) could decline by:

• 11.5% for ECCAS,
• 9.6% for ECOWAS
• and 7.8% for COMESA.

▪ At country level, the effect is likely to be strongest on Zimbabwe, Angola, DRC, Nigeria, Kenya, Tanzania, Ghana, Ethiopia and Mozambique.

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Options for Fiscal Adjustment

While the majority of countries recover lost tax revenue within 5 to 10 years of tariff reductions, the burden in the short run can still be substantial for certain regions and countries. To address the burden

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Option 1: a Financial Adjustment Support Mechanism (FASM). ➢ To finance compensation through a CFTA community levy. ➢ Strictly time bound, accommodating the immediate impact of tariff liberalisation on government revenue ➢ They do not target specific activities or beneficiaries. Option 2: Regional Development Funds are generally more focused on regional infrastructure. For example, the AfDB’s Development Fund (ADF) supports power generation and regional transport initiatives. The Fondo para la Convergencia Estructural del MERCOSUR (FOCEM) also finances regional projects in energy and transport. . Option 3: affected countries impose re- impose tariffs on intra- regional trade for a strictly limited period.

Option 1: FASM

▪ FASMs generally rely on a community levy

• n

imports from third countries, varying from 0.4% to 1%. ▪ A CFTA Community Levy

• f 0.4% on imports from

3rd parties would be sufficient to finance a FASM to cover the tax losses .

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2015 2016 Potential requirement for tariff losses SSA exc. Nigeria, South Africa and Angola $1.1 - $1.7bn $1.5 - $2.3bn Imports (all CFTA members) with the Rest of World $444bn $406bn Finance raised by a 0.2% Community Levy $0.89bn $0.81bn Finance raised by a 0.4% Community Levy $1.78bn $1.62bn

Option 1: FLCM

Time Frame for the Levy and Loss Recovery ▪ The CFTA community would have to impose this levy for approximately 5-10 years, the period for tax revenues to recover ▪ ECOWAS and UEMOA FLCM were

• perational for between 4 to 6 years (and

covered up to 9.5 years of fiscal losses). ▪ Concerns over the impact of tariff reduction

• n society: Cage & Gadenne (2014) find

that for the LICs struggling to recover lost taxes, fiscal expenditure

• n

human development objectives recovers within 3 years because of donor assistance. Management Structure of an FASM ▪ In the context of operationalising a FASM for the CFTA, its narrow focus and limited duration would point to a dedicated, stand alone, facility which could be relatively easy to manage and staff. ▪ This facility would likely be dependent on the decisions about how the CFTA institutions will raise and channel finance.

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Option 1: FLCM

Allocation Criteria for Compensation ▪ It is calculated on the basis of either: intraregional trade shares or incurred revenue losses. The latter is more transparent as the loss can be calculated

• n

the basis

• f

readily available information (MFN tariffs and import data). ▪ Compensation is restricted to the least developed or most disadvantaged in the FTA. WTO Compatibility of a levy ▪ A Community Levy on imports from non-CFTA trade partners would be

• pen to challenge at the WTO because

it risks violating the rules that govern the formation of a preferential trade agreement. ▪ Ultimately, CFTA members will need to decide whether to risk the challenge, and whether the purported gains are worth it.

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Option 2: A/RDF

A/RDF usually supplies support for the loss of tax and tariff revenues support through comprehensive programmes that address government revenue and expenditure management. ▪ Support to adjustment, including implementation, is provided through such programmes as SADC’s Trade Related Facility (TRF). Financing structure A/RDFs mostly rely on a combination of core funding from Donors and other institutions such as development banks. ▪ Member States payments have often been a challenge, sometimes because

• f political crisis (UEMOA/ECOWAS)

and sometimes because of concerns

• ver the potential effectiveness of the

mechanism they are being called on to support. ▪ Different approaches have been taken to try and secure regular payment. For example, ECCAS has placed Central banks in charge of ensuring Member State’s contributions.

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Option 2: A/RDF

Management Structure of an A/RDF ▪ Subpar management of adjustment and regional funds has in some cases contributed to poor resource collection and ineffective implementation.

• This challenge prompted the reform of

the ECOWAS fund to include a strong financial institution capable of mobilizing resources for financing investment (ERIB) and development (ERDF).

• Similarly, UEMOA set up the Regional

Integration Support Fund (RISF) to better manage and finance development projects. Allocation Criteria for Compensation

• There are a range of allocation criteria

and approaches, guided by the scope and principles established for the facility.

• They are generally focused on the least

developed countries and aim at ensuring that the benefits of regional integration are shared – either through increasing competitiveness or supporting social cohesion.

• There is also a strong element of

reducing the burden of implementing regional agreements.

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Option 3: Affected Countries Re-impose Tariffs on Intra-regional Trade

▪ This option emerges from CARICOM and involves the re-imposition of tariffs on intra-regional trade, when an LDC is suffering fiscal loss. This is subject to the endorsement of Member States and is for a strictly limited period. ▪ The approach has several practical advantages.

• It does not require a new institution or financing mechanism and can be easily

applied and monitored.

• It would also avoid the risks of a Community Levy (on third parties) in terms of

WTO compatibility. ▪ However, it is the least attractive from an economics perspective because businesses operate with less uncertainty – they cannot be guaranteed access to markets under the CFTA as Government may re-impose tariffs. ▪ Increased access to markets and collective bargaining is one of the main

• bjectives of the CFTA and thus an option that undermines it should be avoided if

possible.

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Recommendation

▪ Option 1, a FASM, is our recommended solution to the CFTA’s fiscal adjustment challenges.

• It equitably divides the financing of compensation for the lost trade tax and tariff

revenue among Member States.

• Its sole mandate to compensate the selected countries for loss of tax and tariff

revenue makes it the most streamlined and timeous tool to deal with the challenges of fiscal loss.

• It has been tried and tested in the African context. With successful results in

ECOWAS and UEMOA.

• It prioritises the least developed and most disadvantaged in the CFTA
• The risk of a challenge through the WTO is low given that many preferential

trade agreements have used community levies in the past that have gone unchallenged.

• Its successful organization and implementation is likely to have positive spillover

effects in terms of building the CFTA’s organizational and institutional capacity.

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A broader adjustment facility

▪ For the minority of countries that might end up struggling to replace lost tax revenue, even over the longer term, adjustment assistance will undoubtedly be required. ▪ However, given the experience of operationalising adjustment facilities, the management and governance challenges would need to be reviewed and assessed more deeply before a decision is made on a CFTA adjustment facility.

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Background Accommodating Concerns in the CFTA

Challenge Trade Policy Instrument (short term) Support Measure Adjustment Costs Private Sector: Import competition resulting in unemployment, lower wages and bankruptcy.

• Safeguard measures: to protect against

surges in imports that will damage a domestic sector, tariffs can be temporarily imposed, subject to conditions. Within a specified time period, the affected sector will need to be supported in becoming more competitive (as protection is temporary). Where sectors prove not to be competitive, assistance is focused on retraining labour and facilitating exit and re-investment in growth sectors. Unfair competition being used by exporters to enhance their market position. Anti- dumping: to protect against exporters’ anti-competitive practices, anti- dumping duties can be imposed if a domestic sector is being harmed (or potentially harmed). These duties can be imposed subject to conditions. Over the longer term the anti-competitive practices must be proved, or duties will be refunded. Assistance can be provided to enhance co-

• peration on competition and competition policy.

Public Sector Lower trade taxes Fiscal loss compensation: Governments

• f smaller economies can be directly

compensated for their loss in tariff revenue, on a temporary basis. There is also the option

• f

allowing affected countries to re-impose, subject to conditions, tariffs as a temporary measure. Initial rationalisation of tariff regime (reducing exemptions and translating quotas to tariffs) can mitigate the initial impact. Over the longer term, adjustment needs to be part of a wider tax reform to shift the tax base to

• ther sources. The use of VAT to replace lost

tariff revenue has been particularly prevalent.

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Background Accommodating Concerns in the CFTA

Challenge Trade Policy Instrument (short term) Support Measure Social safety net expenditure Either cushioned in the short run by a dedicated fund or often by donor financing. Priority given to expenditure on social safety nets during adjustment. Generally assumed that expenditure needs are transitional. Implementing costs of trade reform. For smaller, poorer countries adopting reform, adjustment support in the form of aid for trade is often required. Institutional development and reform is

• ften

required to ensure reforms are sustainable. De-industrialisation Import competition resulting in the industrial sector contracting. Safeguard measures: to protect against surges in imports that will damage a specific industrial sector, tariffs can be temporarily imposed, subject to conditions. Within a specified time period, the affected sector will need to be supported in becoming more competitive (as protection is temporary). Import competition constraining the development

• f

identified strategic industrial sectors. Infant industry protection: tariffs can be imposed to protect emerging sector, subject to conditions and as agreed. Within a specified time period, the infant industry will need to be supported to become competitive (as protection is temporary).

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Background Assumptions, Risks and Methodological Issues in Research

▪ Using statutory duties as reported in the standard trade databases such as TRAINS and WTO IDB (rather than applied duties) will lead to overestimation of the impact of reducing tariffs on trade flows and on revenues. Revenues predicted by statutory tariffs will almost certainly be higher than actual collected tariff revenue. ▪ Static estimates of aggregate revenue effects – while useful in understanding broad effects – need to be interpreted in the context of a dynamic policy environment. ▪ There is a general assumption that higher trade tariffs are protectionist rather than fiscally motivated (i.e. a sign of narrow domestic tax bases or limited institutional capacity for domestic tax collection). However, the underlying economic structures

• f both fiscal and protectionist goals will influence effective tariff reform.

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Background Assumptions, Risks and Methodological Issues in Research

▪ Tariff revenue losses only represent a part of the fiscal revenue impact of tariff

• reductions. Customs duties are just one tax measure that apply to trade (others

include value-added sales and excise taxes). ▪ Although useful, many CGE studies carry the assumption of a frictionless reallocation

• f

labour and

• ther

factors across sectors, which is an

• versimplification not always supported by the econometric evidence.

▪ Studies that use trade flows to proxy trade liberalisation or use dummies to capture trade reform episodes (around 67% of specifications) tend to find positive effects

• n employment, tax revenue and labour reallocation. While robust, for current

purposes trade flows are a poor proxy for tariff reductions in some cases.

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Background Estimating the Fiscal Impact of Trade Liberalisation

▪ To get to ball park figures for the potential fiscal impact of the CFTA, we have:

• Estimated the total taxes from customs and duties to be an average of 1.9% of GDP (using

estimates from the OECD (2015) and the World Bank (2013))

• Estimated the total tariff revenue reduction from the CFTA to be (i) 10% of total taxes from

customs and duties and (ii) 15%, as the upper limit of the impact assuming trade also grows through reduction in non-tariff restrictions (Mevel & Karingi, 2012).

• Assessed these estimates on the baselines of (a) All Africa (b) All of Sub Saharan Africa

(SSA) and (c) all of SSA excluding the three biggest economies of Nigeria, South Africa and Angola.

• Take the estimate for SSA excluding Nigeria, South Africa, and Angola as the upper-limit for

fiscal compensation as the smallest and poorest economies will be prioritised in any compensation scheme.

• According to this process, the upper limit for fiscal compensation would have been $1.1bn

to $1.7bn in 2015 and $1.5 to $2.3bn in 2016.

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Background Revenue Recovery Time Estimates (Ex-Post)

▪ Time for Fiscal Recovery: 96 trade related trade tax losses (1970-2006)

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Time to recovery MICs LICs Under 5 years 51.5% 42.4% Under 10 years 59.3% 56.2% Under 20 years 70% 60% Source: Cage & Gadenne, 2014

Background WTO Compatibility of a Community levy

▪ There are two options for notifying an FTA– under Article XXIV or the Enabling

• Clause. Article XXIV(5)(b) requires that duties and other trade regulation applicable

to 3rd countries should not be higher or more restrictive than prior to the formation

• f the FTA. There is also a requirement to show that the levy is essential to the

creation of the CFTA. The Enabling Clause provides for the notification of preferential trade agreements involving developing countries. It requires that the agreement not “raise barriers to or create undue difficulties for the trade of any

• ther contracting parties”.

▪ The Community levy would need to be justified whether the CFTA is notified under Article XXIV or the Enabling Clause. The Enabling Clause would be preferable as it has less stringent requirements in comparison to Article XXIV. ▪ The levy would be open to challenge at the WTO. While a community levy of 0.2% to 0.4% is unlikely to create “undue difficulties”, the significance of the levy could also be assessed in terms of systemic ‘principles’ (others may copy CFTA members, creating a snowball effect).

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