negative sloping domestic demand curve and a constant-international infinitive-price- elasticity demand curve.
Figure Nº 5
Supply Price with Tax on Exports Supply Price without Tax on Exports
Demand with Tax on Exports Demand without Tax on Exports
Price without Tax on Exports Price with Tax on Exports
Dealing with a tradable good (commodity), domestic price is the one prevailing in the international market. So, in a small country – price taker - , neither domestic vendors nor purchasers can modify prices. In that scenario it is interesting to see what happens with tax incidence when goods are levied by the VAT and by Tax on Exports at the same time. One important assumption is the usual treatment of the “Destination VAT” - adopted in most legislation in the word, including Argentina - levying import goods, including all tradable good (as foreign competitive exportable goods), as the one of Case 6 saw before25. Figure Nº 5 shows that without VAT and Tax on Exports, producer faces the international price P0 (international price by the corresponding rate of exchange), that is an international infinitive price-elastic demand curve at price P0. Price P0 allows producer to o f f e r t h e q u a n t i t y Q 0 . A p o r t i o n o f t h a t p r o d u c t i s c o n s u m e d i n t e r n a l l y – t h e q u a n t i t y Q 1 – a n d t h e r e s t ( Q 0 – Q 1 ) a r e e x p o r t s .
If the government introduces a Tax on Exports, the burden implies a reduction of the domestic price to P1. This new price and the existence of decreasing costs, lead to the lower sector production Q2. On the contrary, the lower domestic price leads to an increase in the domestic demand (Q3). As a joint effect of less production and more domestic consumption, exports decrease to (Q2 – Q3). Government obtains the Custom revenue equivalent to exports (Q2 – Q3) by the tax rate (P0 – P1), that is, the area DCBF.
Effects of the Tax on Exports on the welfare of factor owners employed in the Agricultural Sector (landlords, entrepreneurs, and rural workers) are obviously negative. But the reduction in monetary terms of sector welfare due to tax on exports is higher that the amount of revenues obtained by the government; the loss is equivalent to trapezoid P0ABP1. This loss in welfare can be divided into four areas: DCBF – corresponding to the tax revenue obtain by the government -; the area P0EFP1 – corresponding to the implicit transfer and consequent welfare improvement of domestic consumers -; and, the two triangles EDF and ABC - representing the excess burden of the tax -.
Following the traditional methodology of sector tax burden measurement only the area corresponding to tax revenue obtain by the government is taken into account. However,
25 Conceptually, to levy imports with the VAT, is equivalent to levy imports with a custom duty with similar tax rate. Actually, the value added of the good produced in a foreign country is the tax base of any custom duty.