Monday, November 21, 2005

Fiscal policy and supermarkets: a strange connection

Gordon and Li have a new paper explaining puzzles in the tax structure of developing countries. They note that many of the puzzles can be explained by the prevalence of the underground economy (compared to the alternative hypothesis that political economy constrains the tax authorities from exacting revenues.) The tax base consists of the formal enterprises which rely heavily on the financial sector (rather than cash transaction). It turns out that tariffs are one way of protecting the tax base (while itself a means of extracting tax revenues). Some unprincipled parties may use Gordon and Li's argument to promote tariff protection (I'm not saying Gordon and Li themselves do so). That argument (fiscal implications of tariff protection) in my mind suggests a serious practical point against tariff reform.

My thoughts then drift to an apparently unrelated topic - the rise of supermarkets. Tom Reardon has argued that the supermarket boom in developing Asia transformed agribusiness in these countries. I asked him whether there are strong fiscal implications as well. He replied, well in China one reason the small retailer lobby has not made much headway fighting the foreign retail juggernaut is that they hardly pay taxes anyway, and are viewed by the authorities as somewhat useless.

Further to Gordon and Li's point: supermarkets sell plenty of imported goods, so it is not clear whether there is a net protection effect from tariffs (it would depend on the tariff structure, I guess). Overall supermarkets represent a dramatic shift away from the underground economy. This would tend to undermine the fiscal protection argument against tariff reform. So - however wierd this sounds - optimum benefits from tariff reform may have to be accompanied by retail trade deregulation, which would expand the scope of the formal sector. If this sounds half-assed, lemme know.

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