Export taxes in the EPA negotiations: Is it worth the price?

17 March 2014

Export taxes are one of the few contentious issues holding back the EPA negotiations in both the EAC and the SADC. Whereas both configurations see export taxes as a tool of industrial policy and an integral part of their policy space, the EU contends that export taxes restrict access to raw materials and are trade-distorting – even though they are not WTO-illegal.

This article examines the divergent views of the parties, critically assesses the evidence on the developmental impact of export taxes and proposes options for advancing the negotiations in this area.

An export tax is a duty applied on products before they are exported. Export taxes are used for various reasons, including as a source of government revenue, a mechanism for domestic price stabilization, a means to achieving food security and an instrument for promoting industrial development.

The effects of an export tax in a “small” economy – that is, a country that takes world prices as given – are unambiguously negative. The export tax would cause the domestic price of the product on which it is imposed to fall, thus increasing “consumer surplus”. The government collects revenue from the tax but “producer surplus” is reduced. The net effect is a fall in national welfare. This “deadweight loss” arises because the export tax entails an inefficient allocation of resources: the lower after-tax price to exporters causes the output of a product in which the country has a comparative advantage to fall. If the economy were large, the export tax could lead to a net gain by improving the country’s terms-of-trade. But this assumption is probably inapplicable to the African countries currently negotiating an EPA.

At the empirical level, however, there is a dearth of evidence on the welfare effects of export taxes.  A notable recent study estimated the average export tax on global merchandise trade in 2007 at 0.48 percent  (Laborde et al., 2013). The authors simulate the effects of the removal of all export taxes on global welfare. They find that world income would increase by 0.23 percent. If this figure looks smallish, consider that it is much bigger than the potential gains under a completed Doha Round.

Since export taxes are welfare-reducing, an alternative and more efficient instrument to promote higher value-added activities might be production subsidies. However, production subsidies require the government to spend resources and, so, may not be feasible for the cash-strapped governments of sub-Saharan Africa. Moreover, they are generally classified as “amber box” measures and are WTO-illegal. Conversely, export taxes are not prohibited by the WTO, and they raise revenue. Hence, whereas a production subsidy is economically efficient, export taxes are politically attractive.

Divergent negotiating positions
The EU is strongly against export taxes. This is evident in its démarche to reduce or eliminate export taxes in the Doha Round. Its Raw Materials Initiative reveals a key reason motivating the EU’s position: export taxes restrict market access to critically needed raw materials and inputs, and raise their prices. Partly for this reason, the EU has insisted on a clause on export taxes in the EPA negotiations, which essentially prohibits new export taxes from being imposed, or their current levels from being increased, except under very specific circumstances.

For example, Art. 15 of the EU-EAC Framework EPA states:

    1. The Parties shall not institute any new duties or taxes in connection with the exportation of goods to the other Party that are in excess of those imposed on like products destined for internal sale.

2. Notwithstanding paragraph 1, the EAC Party can impose a duty or tax in connection with the exportation of goods, with the authorization of the EPA Council, under the following circumstances:
(a) to foster the development of domestic industry; or
(b) to maintain currency value stability, when the increase in the world price of an export commodity creates the risk of a currency value surge.

3. Such taxes should be enforced on a limited number of products for a limited period of time, and reviewed by the EPA Council after 24 months

The EU-SADC Interim EPA contains a similar provision in Art. 24 – although the specific details vary. In both cases, the EPA draft text states that no new export taxes may be imposed. However, two exceptions are admitted in the case of the EAC – to foster the development of domestic industry and to maintain currency stability – and three in the case of the SADC – to raise revenue, to protect infant industries and to protect the environment. Even then, such taxes can only be imposed with authorization of the EPA Council, on a “limited number of products” and for a “limited period of time”.

The common position of the two blocs is that the language on export taxes is strewn with grey areas. Moreover, they fear that the EPA Council’s decision may take long and that the outcome may not be in their favour. Both the EAC and the SADC view the EU’s demand as unfairly restricting their use of export taxes as a tool of industrial development and raw material beneficiation and, thus, limiting their policy space. Some stakeholders assert that this a matter of sovereign right and have gone so far as claiming that the issue of export taxes was non-negotiable.

To their credit, export taxes are not WTO-incompatible and so there was no need for the EU to insist on them for the EPA to comply with GATT Art. XXIV. Nevertheless, export taxes are trade-restricting and constitute a “beggar-thy-neighbour” policy. Perhaps for this reason, it has become fashionable for modern free trade agreements (FTAs) to include provisions on export taxes. The SADC Protocol on Trade includes a similar clause. Art. 5 of the Protocol states: “Member States shall not apply any export duties on goods for export to other Member States.” What is more, the Protocol does not admit any of the exceptional circumstances allowed in either the SADC or the EAC draft negotiating text.

Do export taxes work?
It appears that the African negotiators’ position on export taxes is influenced more by emotions than by economics. There is generally a dearth of evidence on the effectiveness of export taxes as a tool of industrial development. A notable exception is Piermartini (2004). Even then, the evidence is largely anecdotal and is limited to a few sectors and countries, none of which African. On the other hand, there are claims about export taxes triggering local processing activities in a few African countries, such as Uganda where an export duty on raw hides led to the development of local tanneries and leather products, and Namibia, where export taxes on beef encouraged a slaughtering and meat processing industry to emerge. While these claims need to be verified, recent evidence from Tanzania suggests that a 20 percent export levy on raw cashew nuts, which was subsequently raised to 40 percent and then to 90 percent, failed to encourage local processing of cashew nuts. This is because the profit margin on processed cashew was smaller than that on raw cashew even after paying the export levy, and the country’s inability to control borders led to large amounts of cashew nuts being smuggled out, and little revenue, if any, being pocketed by the government. For similar reasons, a 90 percent export duty on raw hides and skin has failed to catalyse development of leather processing activities.

The fact remains that export taxes alone cannot catalyse industrial activity. The latter presumes the existence of local knowledge, technology and processing capacity that the export tax incentivizes producers to plough back into operation. An export tax itself cannot lead to the development of productive capacity – within a reasonable period of time – where it does not exist. On the other hand, if the preconditions for industrial activity exist, export taxes may be redundant. It is well known that the low level of industrialization in Africa is generally the result of a poor business environment, high costs of production, and low skills development (Page, 2012). It is difficult to argue how export taxes could improve any of these fundamentals.

It is therefore high time that African negotiators get real on the issue of export taxes, and let their emotional attachment to something that hardly seems to have worked to give way to concrete development opportunities. All trade agreements involve a degree of national sacrifice, which countries make in the expectation of larger benefits in the future. Giving up on the use of export taxes is a small sacrifice with a great promise.

The way forward
Export taxes are by far the most contentious issue in the EPA negotiations. One way to progress on this question is for the EU to make proposals in other areas that can achieve broadly the same objectives as those claimed of export taxes. For example, if the objective is really to encourage local processing of raw materials, the EU can commit to an enhanced development chapter that provides greater amounts of Aid for Trade and technical assistance to help EAC/SADC countries build their productive capacity.

Another option – a more technical one – is to clarify the text on export taxes. For example, “limited number of products” and “limited period of time” need to defined, and the EPA Council’s decision-making process explained. It is crucial to assure member-states of both blocs that this process will be fair and inclusive. It should also be possible for the EU to extend the allowable “exceptional circumstances” to include revenue-raising and the protection of the environment as additional reasons for imposing export duties, as in the SADC EPA draft text.

Author: Vinaye Ancharaz - Senior Development Economist at ICTSD.

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