Taxation and Fiscal Adjustment

The higher levels of investment and growth stimulated by the proposed Free Trade Area (FTA) should, in theory, yield fiscal benefits. In practice, however, there may be adverse fiscal effects arising from two different sources. First, the losses in customs revenues due to falling tariffs on intra-regional trade and the effects of trade diversion could, for many countries, outstrip any gains in other tax revenues (arising from increased levels of economic activity generally). Second, the potential gains in tax revenues are unlikely to be fully realised due to institutional weaknesses in regional tax systems. For this reason, the sustainability of the FTA may depend on individual countries, first, adopting appropriate fiscal measures to offset any losses in customs revenues and, second, reforming tax structures so as to secure the full fiscal benefits of increased growth in the longer term. Failure to address any revenue shortfalls due to decreases in customs revenue will cause a deterioration of countries’ macroeconomic positions, which, as discussed in Chapter 2, are already fragile in a number of member countries. Failure to address the structural issues risks undermining the potential benefits of the FTA.