Coordinated Tax-Tari Reforms, Informality, and Welfare Distribution

The paper studies the revenue, eciency, and distributional implications of a simple strategy of ofsetting tariff reductions with increases in destination-based consumption taxes so as to leave consumer prices unchanged. We employ a dynamic micro-founded macroeconomic model of a small open developing economy, which features an informal sector that cannot be taxed, a formal agricultural sector, and an import-substitution sector. The reform strategy increases government revenue, imports, exports, and the informal sector. In contrast to Emran and Stiglitz (2005), who ignore the dynamic effects of taxes and tariffs on factor markets, we and an eciency gain, which is unevenly distributed. Existing generations benefit more than future generations, who depending on pre-existing tax and tariff rates and the informal sector size even may become worse off.