The Fiscal Impacts of Trade and Investment Treaties

There is a renewed global push to mobilize resources to meet glaring global infrastructure gaps, the Sustainable Development Goals, the Paris Climate Agreement commitments and generally improve standards of living. A core component of such resource mobilization will be the generation of domestic resources through taxation. Whereas tariffs form a miniscule share of public revenue in industrialized countries, they can be the largest source of public revenue in large parts of the developing world. Trade liberalization by definition reduces those tariffs, with the hope that liberalization will trigger new levels of efficiency that will bring productivity benefits that can support a broader tax base.

A new journal article in the Journal of Political Economy by Kevin P. Gallagher and Devika Dutt builds on previous work to examine the impact of new measures of trade liberalization. Their analysis considers the impact of trade liberalization on the fiscal balances of government, looking at tax revenue, government expenditure and government debt.

The authors find that, on average, trade liberalization has reduced the amount of tariff revenue collected. Furthermore, trade liberalization is not correlated with an automatic compensation for lost tariff revenue through other taxation measures. In some cases, trade and investment treaties are linked to a reduction in total fiscal revenues and an increase in government debt. The authors explain that emerging market and developing countries need to be mindful of the potential impacts of trade and investment liberalization on their ability to mobilize domestic resources for development. While the overall results are mixed across different kinds of liberalization and resource mobilization, these findings show that trade liberalization has the potential to decrease fiscal revenue and increase external debt levels.

This journal article was originally published as a working paper in July 2020.