COMPENSATING LOST REVENUE IN REGIONAL TRADE AGREEMENTS

According to The World Bank the increase of free trade agreements and customs unions since the early 1990′s has been significant and has promoted economic integration at the regional level. However, as the shifts occur organizational and fiscal adjustments cannot be avoided and in some cases special provisions to cover adverse impacts on countries economic methods have been devised for mitigation of negative trade effects among members.

One such provision compensates for losses of government revenue from intraregional tariff reductions. Regional trade liberalization does not necessarily lead to revenue losses if tariff reductions activate a proportional increase in trade flows expanding economic activity and if government revenues from trade taxes increase. Revenues from taxes on value-added (VAT) and income taxes are likely to grow because of higher domestic consumption resulting from lower prices of goods and allocation of resources in the economy. Nevertheless, if revenue shortfalls occur, countries with rigorous administrative capacity will often be able to recover the losses by strengthening domestic indirect taxation, broadening the tax base, and increasing the efficiency of raising funds for the government. Notwithstanding, poor countries, and particularly the least developed ones lack sufficient administrative capacity and a well-functioning domestic tax system. Under these conditions poor countries tend to rely heavily on trade taxes as sources of government revenue and lowering or eliminating tariffs on trade with regional partners can become a significant risk to a country’s fiscal position. For instance, the prospective impact of the Economic Partnership Agreement between the European Union and the Economic Community of West African states (ECOWAS) indicate that some of the participating African countries could lose more than 20 percent of their government revenues from preferential tariff reductions. In order to lessen such potentially impact on fiscal policy, revenue loss compensation arrangements (RLCA’s) have been introduced into some regional integration initiatives (RII’s). Most RLCA’s involve the establishment of a compensation fund from which payouts for tariff revenue losses are made.

The World Bank indicates that the RLCA’s in the Common Market of Eastern and Southern Africa (COMESA) and the Economic Community of Central African states (ECCAS) appear even further away from effective implementation. By contrast, the revenue sharing funds in the southern African Customs Union (SACU) and the West African Economic and Monetary Union (WAEMU) have been operational for several years. “RLCA’s differ in their design and implementation characteristics, particularly with respect to their duration and their handling or resource mobilization and payout criteria.”

The funds available for compensation or revenue sharing are distributed among member countries in proportion to their shares in total intraregional imports. Compensation is paid on the basis of submitted customs declarations on intra-RII trade for the period under consideration and the loss in revenue associated with the non-application of most-favored-nation (MFN) tariffs to partner country trade.
 There is no doubt that poor countries need help if they are to be assimilated successfully into the global economy. The WTO can help but it can offer no guarantees, it can provide only opportunities.