Trade And Welfare Effects of Export Taxes

Trade And Welfare Effects of Export Tax

Export restrictions (such as export tax) are not uncommon among countries. There are many reasons why countries may want to impose export restrictions. One of the reasons can be the difference between domestic supplies and the demands of certain goods. For instance, during the food crisis from 2007 to 2008, several developing countries imposed export restrictions on their agricultural commodities to raise their food security. Another reason can be that the governments want to support high-value manufacturing industries. By imposing export taxes on unprocessed materials that are used as inputs to produce higher-value goods, the governments can lower the domestic prices of unprocessed materials and indirectly subsidized higher-value industries. Furthermore, imposing export tax raises revenues for the governments. In other words, governments can use export tax as a source of funds to do other things.

Besides the above reasons, if a country that imposes export taxes is a large country, it can influence the world price. If a large country feels that the world price is not high enough and wants to improve its terms of trade, it may impose export taxes to reduce the number of goods being exported to the world and increase the world price. Lastly, export taxes are useful to fight domestic inflation. When tax is imposed on exports, the domestic prices of those exports will fall. The price decreases can help the governments relieve the effect of high inflation.

There are several downsides to the export restrictions. One of the downsides is that export taxes hurt producers who export their goods to foreign countries. Export tax can reduce the domestic producers’ competitive advantages, thus, put them in difficult situations. Another drawback of export taxes is that the tax reduces the foreign-exchange reserves. This will create difficulties for the governments to pay back foreign debts or import foreign goods.

Before going into the analysis of the impact of export tax on consumers, producers, and the public in small and large countries, it is important to understand the concepts of consumer surplus and producer surplus. Consumer surplus can be understood as a measure of the welfare that consumers get from buying commodities. It is computed by subtracting what the consumers actually paid from what they are willing to pay. Producer surplus is an indication of the welfare that producers get from selling the commodities. It is computed by subtracting the price that consumers would accept to produce the commodities from what they actually took from selling the goods.

Export Taxes in a Small Country

Trade And Welfare Effects of Export Taxes - Export Tax in a Small Country

Suppose the initial domestic price is P0 and equal to the world price PW. At the initial price P0, the small country’s domestic supply S0 is greater than its domestic demand D0. As a result, the difference between domestic supply and demand is exported to foreign countries at the price PW.

When the small country’s government imposes taxes on the exports, domestic producers will prefer the domestic market because it is untaxed. Thus, domestic supply will increase, and domestic prices will decrease. The domestic price will keep decreasing until it reaches P1 = PW x (1 – t). Because it is a small country, the world price is not influenced by the export tax and remains unchanged. When the domestic price reaches the world price minus the export tax, the producers will be indifferent between selling to the domestic market and exporting to foreign countries.

Domestic consumers gain the benefits from the tax because they enjoy a greater amount of goods (D1 > D0) at a lower price. The consumer surplus increases by area a. The producers suffer because they produce less (X1 < X0) and sell at a lower price (P1 < P0). The producer surplus decreases by areas (a + b + c + d). Finally, the government also gains from the export tax by getting the revenue equal to the area c. The end result is a loss of domestic welfare, which is the area (b + d).

As it shows, the export tax redistributes welfare from domestic to the government and domestic consumers. However, the overall national welfare is lower. Thus, the governments in small countries should not impose the export tax, assuming $1 of consumer surplus is the same as $1 of producer surplus and $1 of public revenues.

Having said that, small countries may still want to consider the use of tax under certain circumstances. For example, if a small country is suffering from food scarcity, it should impose export taxes on food products to secure the food supplies and stabilize food prices.

Large Country Case

Trade And Welfare Effects of Export Taxes - Export Tax in a Large Big Country

In the case of a large country, the world price is affected by the export tax. This is built on the speculation that the large country accounts for a big share of goods that are exported to the global market. When the large country imposes an export tax on the exports, the number of exports in the world market will decrease. Thus, the world price of exports will go up.

The effect of this kind of export restriction on consumers is the same as the effect in the small country’s case. The domestic price will decrease from P0 to P1 and demand will increase from D0 to D1. Because the consumers enjoy more goods at a lower price, the consumer surplus expands by the area a. Similarly, the effect of export tax on producers is also the same as in the small country’s case. Because the producers sell fewer goods at a lower price, the producer surplus shrinks by the areas (a + b + c + d).

For the government’s revenues, they are different from the small country’s case because of the increase in the world price. The government’s revenues rise by the area (c + e) in this case. If the area e is greater than areas (b + d), the total domestic welfare will increase because of the export tax. Areas (b +d) indicate domestic welfare losses from the tax while area e indicates the increase in terms of trade. Before the imposition of export tax, each unit that is exported is traded at the price PW in the world market. After the imposition of taxes, the units (X1 – D1) are now traded at a higher price PW1 in the world market. Thus, the terms of trade increase by the difference between PW and PW1.

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