Working Paper: CEPR ID: DP1304
Authors: Ben Lockwood
Abstract: This paper investigates whether it is possible to find Pareto-improving commodity tax reforms that harmonize taxes between two countries when governments supply public goods and thus have revenue requirements. To focus on the basic issues, we consider a Ricardian model of trade with elastic factor supply and two traded goods, and suppose that initial taxes are Nash equilibrium ones. This allows a complete characterization of the conditions under which Pareto-improving reforms exist using simple geometric arguments. These conditions are completely determined by: (i) the configuration of initial taxes across countries; and (ii) whether the two goods are substitutes or complements. An example suggests that harmonization is unlikely to be Pareto-improving if the revenue requirement is high, and the demand for imports relatively price elastic, in both countries. An alternative definition of harmonization, difference harmonization, which may yield Pareto-improvements under more general conditions, is proposed.
Keywords: commodity tax reform; tax harmonization
JEL Codes: H21; H41; H87
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high revenue requirement (L97) | ineffectiveness of tax harmonization in achieving Pareto improvements (H21) |
| less heavy taxation of imported good (H29) | welfare in both countries falls (I39) |
| difference harmonization (L15) | Pareto improvements under broader conditions (D69) |