Domestic Resource Mobilization and the Trade and Investment Regime: The Need for Policy Coherence

Florianópolis, State of Santa Catarina, Brazil. Photo by Gabriel Rodrigues via Unsplash.

The challenges that developing countries have faced in terms of fiscal constraints, debt overhang and access to essential medicines existed long before COVID-19 and will persist long after it is gone.

In November 2019, the Boston University Global Development Policy Center partnered with the Intergovernmental Group of 24 on International Monetary Affairs and Development (G-24) to convene a working group of experts to examine the extent to which the World Trade Organization (WTO), free trade agreements (FTAs) and international investment agreements (IIAs) are compatible with domestic tax revenue mobilization in emerging market and developing countries. The interdisciplinary group of experts, from academic institutions, international organizations and civil society, concluded that the trade and investment regime poses a number of constraints to nations attempting to mobilize their tax system for development.

Their findings are spelled out in a collective June 2020 report, Domestic Resource Mobilization and the Trade and Investment Regime:

  • Trade and investment treaties significantly decrease the amount of tariff revenue, which is not always re-captured by a shift to other forms of taxation. Indeed, increases in the number of trade and investment treaties is strongly associated with increases in external debt burdens.
  • The estimated potential loss in tax revenues due to trade misinvoicing is equivalent to about 20 percent of total revenues collected each year, and was close to $1 trillion in 2015 alone.
  • The potential tariff loss from e-commerce moratoriums at the WTO alone is upwards of $10 billion per year.
  • Investment agreements and trade treaties with stringent investment provisions further undermine nation-states’ ability to generate tax revenue.

Legal analyses in the report found that rectifying these problems within the trade and investment regime also face significant constraints:

  • WTO law puts constraints on taxing certain activities, especially imposing new taxes in service sectors.
  • The WTO restricts developing countries from exploiting their competitive advantages in the manufacturing of goods. At the same time, the current system incentivizes developed countries to implement special tax zones in areas where they have comparative advantages, such as financial services, telecommunications, and banking.
  • Many free trade agreements (FTAs) and bi-lateral investment treaties (BITs) put contingent liabilities on developing countries in the form of obligations to compensate foreign investors plus the costs of the litigation of Investor-State Dispute Settlement (ISDS) systems.
  • The taxation ‘carve outs’ in FTAs and BITs are becoming increasingly narrow, and double taxation treaties are also increasingly narrow with additional ISDS ramifications.
  • Rules both at the WTO and in FTAs further constrain countries from taxing the rapidly growing digital sector, through various rules prohibiting customs duties on electronic transmissions. New proposed rules are poised to ‘lock in’ advantages of lead digital firms by reducing or eliminating any restriction on their ability to operate globally while simultaneously restricting the space for governments to regulate the digital economy in the public interest.
  • Many FTAs and BITs accentuate the problems developing countries have in the event of a sovereign debt restructuring.

While each chapter of this report offers a number of specific policy recommendations, this report offers these general policy recommendations to align the trade and investment regime with the goal of strengthening domestic resource mobilization and capacity for tax and other revenue collection:

  • Countries should commit to aligning new and existing trade and investment treaties with the SDG 17.1 and embark on ex-ante and ex-post analyses to help nation-states and the global community better understand the fiscal implications of trade and investment treaties.
  • WTO reform discussions should have the SDGs and the Paris Agreement at their core with particular attention to SDG 17.1. To that end, the moratorium on e-commerce should be lifted, and negotiations on the digital economy should ensure that developing countries have the right to regulate the digital economy for taxation and beyond. Finally, there should be disciplines making trade misinvoicing actionable and the Trade Facilitation Agreement should be bolstered in order build the capacity of member states to take necessary actions to limit misinvoicing.
  • Regional and bilateral trade and investment treaties should also be aligned with the SDGs and the Paris Agreement, and should not limit the ability of nations to mobilize domestic resources for development through taxation. Treaties should provide policy space to tax the digital economy, natural resource based activity, and foreign firms in order to make the transitions necessary to achieve sustainable development without concern for contingent liabilities to the public purse.

The report concludes by noting that a values-driven and rules-based global trade and investment regime could become an important instrument to achieve global prosperity in an inclusive and climate friendly manner. The authors argue bold action is needed to align the current system to these ends.

Read the Report