Value-Added Taxes and International Trade: The Evidence

This paper examines the effect of value-added taxes (VATs) on international trade. Destination-based VATs are commonly thought to encourage exports, since exports are exempt from tax while imports are taxed. Economic theory implies that exchange rate adjustment prevents destination-based VATs from affecting exports and imports, since exchange rate appreciation completely undoes the effects of introducing a VAT. Indeed, this proposition is so well accepted among economists that it has not been subjected to serious prior testing. Evidence from 136 countries in 2000 indicates instead that reliance on VATs is associated with fewer exports and imports. Countries using VATs have one-third fewer exports than do countries not using VATs, and 10 percent greater VAT revenue is associated with two percent fewer exports. A similar pattern appears in an unbalanced panel of 168 countries from 1950-2000, in which VAT use is associated with 12 percent fewer exports. These patterns persist with the inclusion of income and geographic controls, and while the effect of VATs on exports is stronger among low-income countries than it is among high-income countries, there is a significant negative effect of VATs on exports even among high-income countries. The behavior of American multinational firms in 1999 is consistent: ten percent greater local VAT collections are associated with 5 percent fewer exports by local American-owned affiliates. Two features of VAT implementation may account for these effects: VATs tend to be imposed at higher rates on traded goods than on nontraded goods, and exporters often receive only incomplete VAT rebates. JEL Classifications: H87, H25, F17, F23. Mihir A. Desai James R. Hines Jr. Harvard Business School University of Michigan Morgan 363 Business School Soldiers Field 701 Tappan Street Boston, MA 02163 Ann Arbor, MI 48109-1234 [email protected] [email protected]