India just retaliated with new tariffs on U.S.goods. Here’s why developing economies like tariffs.

6 minute read


In a week that saw President Trump tweet against a wide range of companies and countries, India got its own shout-out for high tariffs. India joined the European Union and China to push back against U.S. steel and aluminum tariffs, and notified the World Trade Organization (WTO) last week that it would impose higher import tariffs on 30 U.S. goods, including almonds, shrimp and chocolates.

What are the consequences for India of jumping into Trump’s trade war? Most economists assert that increased tariffs are bad for countries because they drive up the cost of goods and reduce efficiency.

The short-term revenue can be tempting

The findings of Ida Bastiaens and Nita Rudra’s forthcoming book suggest that some developing countries such as India may be especially prone to the temptation of short-term revenue that tariffs can bring. The bottom line? Poorer democracies might not find the current trade wars quite so devastating. Here are four things to know:

1) Globalization makes it harder for developing countries to collect tax revenue. Poorer countries have long relied on trade taxes, especially import tariffs, for government revenue – which sometimes account for 20 or 30 percent (or more) of revenue — such as in India, Jordan and the Philippines in the early 1990s. Tariffs are easy to collect because they involve straightforward monitoring at a centralized border area and don’t require a complex bureaucracy to manage.

But as developing countries join the global economy, governments have to drastically lower tariffs to enter the WTO and successfully negotiate trade agreements. This tectonic shift leads to a rapid loss of government income or a “revenue shock.”

Here’s an illustration: Vietnamese economists in 2015 estimated that joining the Trans-Pacific Partnership and Asian Economic Community could mean over $1.9 billion in lost budget revenue, as tariffs come down.

2) Telling countries to collect taxes differently isn’t an easy fix

The solution advocated by the World Bank and IMF is not tariffs and a trade war, but to replace “easy to collect” tariffs with “hard to collect” domestic taxes, such as broadening the income tax base and implementing value-added taxes. This isn’t easy to do – developing countries do not have the administrative infrastructure, personnel or experience to effectively collect complex domestic taxes.

Here’s an example of a value-added tax in Andhra Pradesh: Yes, a cow urine tax became a way for one of India’s largest states to replenish government coffers. Cow urine is used in herbal medicines and facial cleansers, and also draws considerable R&D for its hemotherapeutic potential. The economics of globalization help explain the rise of odd taxes like the one on cow urine — which is both inefficient, and in India, religiously sensitive.

Yet one of the primary benefits of globalization is that it often leads to a robust private sector, which means that taxing corporations should be a no-brainer for offsetting tariff revenue losses. But this is particularly hard in a global economy. Corporations demand lower tax rates, credits, exemptions and rebates to better compete globally – and they often find more ways to evade taxes (e.g., tax havens, transfer pricing) in a globalized system.

Advanced economies also grapple with these issues, of course. But it is particularly consequential to the fiscal health of poor countries because they face revenue as low as 10 percent of GDP, on average, in comparison with 40 percent in the advanced industrial nations Underdeveloped tax administrative systems, weak enforcement mechanisms and a limited number of registered taxpayers mean that poor nations struggle to raise sufficient revenue for their needs. So, declining revenue from trade, and voter and corporate resistance to higher taxes really matter.

3) China and India aren’t in the same boat

Not all developing nations struggle equally. Bastiaens and Rudra’s forthcoming book found that authoritarian governments – like China – have had far more success increasing domestic tax revenue alongside globalization.

Authoritarian governments can impose tax reforms by fiat and use coercion to increase compliance by citizens — and firms — outside their small loyalist circle. China, for instance, relies on a strong-armed police force to ensure compliance; historically, officials would beat farmers to death over tax payments. More recently, wealthy elites have been executed for tax fraud. This doesn’t mean that individuals or firms never cheat – but the risk of heavy punishment is so high that tax evasion is less likely to occur than it does in democracies.

In contrast, democracies have to figure out how to increase tax revenue while contending with unhappy voters. Often, permitting tax avoidance is the easiest path to reelection. One recent estimate suggests that only 3 percent of Indian citizens pay an income tax.

This is the grand irony on globalization and democracies. Many international economists predicted that globalization would lead to higher revenue because of private sector growth. But citizens of democracies in the developing world suffer when politics constrain their governments’ ability to tax and redistribute — especially now with declining tariff revenue under globalization.

4) Retaliatory tariffs do much more harm than good

For a democratic developing country like India, retaliatory tariffs and highly specific taxes like cow urine may seem like a tempting source of revenue in the short term. But developing country governments are mistaken if they perceive any revenue potential of recent tariffs in the long run.

India’s retaliatory tariffs are expected to raise $240 million in revenue, only 0.1 of a percent of revenue collected by the Indian government. Also, this revenue boost could prove fleeting: Indian consumers can opt to buy less or other goods, while the U.S. could voluntarily limit exports to India.

The recent tit-for-tat trade war is only likely to bring further fiscal and macroeconomic problems for India.

If India doesn’t want to retreat from globalization and all its benefits, but still needs cash, it will need to focus on enforcing tax rules and implementing smarter policies to get both voters and firms to agree to pay taxes.

Ida Bastiaens is assistant professor of political science at Fordham University. She is the author of “Democracies in Peril: Taxation and Redistribution in Globalizing Economies” (Cambridge University Press, 2018).

Nita Rudra is professor of government at Georgetown University. She is the author of “Democracies in Peril: Taxation and Redistribution in Globalizing Economies” (Cambridge University Press, 2018) and “Globalization and the Race to the Bottom in Developing Countries: Who Gets Hurt” (Cambridge University Press, 2008)