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GTAP Resource #2001

"Confronting the Issue of the Elasticity of Customs Evasion in Mozambique: An Empirical Study"
by van Dunem, Joao and Channing Arndt

This study examines empirically the causal relationship between border tax rates and evasion in a representative Sub-Saharan African country, Mozambique. By nature, evasion is not easy to measure. The methodology employed here follows an approach used by Fisman and Wei (2004) in the context of trade between Hong Kong and China. The approach aligns and compares (at the product level) bilateral trade flow data between Mozambique and its largest trading partner, South Africa, opening the possibility of measuring evasion with some precision. In particular, the ratio of South African declared exports to Mozambique (X) and Mozambique’s recorded imports from South Africa (M) determines the measure of evasion. This measure is then related to the total fiscal burden at the border.

The baseline model posits a linear relationship between the logarithm of our measure of evasion (X/M) and a “Taxes” variable, a central variable defined as the sum of applicable taxes levied at the border for a particular product. This model is given by:
Log (X/M) = á + â Taxes + å. (baseline model).
Due to the inability of Mozambican customs to exclude transshipments via South Africa, the model is slightly transformed to:
Log (X/M*) = á* + â Taxes + v. (transformed model where M* and á* are newly defined variables).
The coefficient â indicates the responsiveness of tax evasion to tax rates. Results show an estimate of â positive, statistically significant and equal to about 1.4. The paper concludes that high tax levels are associated with high levels of underreporting of import values and that tax rates have a strong and positive effect on tax evasion in Mozambique. For every percentage point increase in the customs tax rates, evasion increases by 1.4%. This degree of responsiveness corresponds to about half of the sensitivity found by Fisman and Wei (2004) for trade between Hong Kong and China.

Another concern of this paper is to investigate for product misclassification. Detecting whether higher taxed goods are being mislabeled as lower taxed goods requires an extension to our baseline model. An augmented model incorporates a new variable, Av_Tax_Sim, defined as the average tax applied at the border to similar products. The augmented model hence yields:
Log (X/M*) = á* + â1 Taxes + â2 Av_Tax_Sim + v.
Product mislabeling implies that â2 is negative. A lower tax on similar products increases the incentives to misclassify into the similar but less highly taxed category. Results strongly confirm the presence of fraudulent classification of merchandise.

Once obtained, the estimates permit one to infer overall levels of evasion. The general evasion rate based on the regression estimates is approximately equal to 36% of recorded imports. In words, on average, for each three units of imports that enter the country officially, slightly more than one unit is smuggled. For more highly taxed products, the evasion rat is higher. For example, for a classic consumer product, such as a television, which is subject to the top tariff rate, evasion amounts to about 57% of official imports. Or, for consumer products subject to the top tariff rate, for every two units that are imported officially, one unit is smuggled.

Lastly, the estimates permit analysis of the revenue implications of lower trade taxes. Fisman and Wei (2004) found China to be on the downward sloping side of the “Laffer curve” implying that reduced rates actually increase revenue. While near the top of the Laffer curve, revenue remains upward sloping with respect to the tax rate in Mozambique. Reductions in taxes levied at the border would imply some revenue losses.

In sum, high levels of evasion of border taxes prevail in Mozambique and evasion is significantly related to the total tax burden at the border. Evasion rates are particularly high, via product misclassification, when divergent border tax rates are applied to similar products. The estimates indicate that reduced evasion rates would substantially soften the revenue implications of reduced tariff rates at the border. Nevertheless, revenue implications would likely be negative implying a need to identify other potential sources of revenue as part of a trade liberalization program.

Resource Details (Export Citation) GTAP Keywords
Category: 2006 Conference Paper
Status: Published
By/In: Presented at the 9th Annual Conference on Global Economic Analysis, Addis Ababa, Ethiopia
Date: 2006
Created: Arndt, C. (4/28/2006)
Updated: Arndt, C. (4/28/2006)
Visits: 3,628
No keywords have been specified.

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