DP1304 Commodity Tax Harmonization with Public Goods - An Alternative Perspective

Author(s):	Ben Lockwood
Publication Date:	December 1995
Keyword(s):	Commodity Tax Reform, Tax Harmonization
JEL(s):	H21, H41, H87
Programme Areas:	Industrial Organization, International Trade and Regional Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=1304

This paper investigates whether it is possible to find Pareto-improving commodity tax reforms that harmonize taxes between two countries when governments supply public goods and thus have revenue requirements. To focus on the basic issues, we consider a Ricardian model of trade with elastic factor supply and two traded goods, and suppose that initial taxes are Nash equilibrium ones. This allows a complete characterization of the conditions under which Pareto-improving reforms exist using simple geometric arguments. These conditions are completely determined by: (i) the configuration of initial taxes across countries; and (ii) whether the two goods are substitutes or complements. An example suggests that harmonization is unlikely to be Pareto-improving if the revenue requirement is high, and the demand for imports relatively price elastic, in both countries. An alternative definition of harmonization, difference harmonization, which may yield Pareto-improvements under more general conditions, is proposed.