Tax policy reforms in Thailand : a computable general equilibrium approach

Abstract

Thailand has been one of the most rapidly grov/ing developing countries since 1960s. The economy has diversified from agricultural to manufacturing and service activities as it has developed. Economic growth was driven by an outward-looking stance which ensured that the economy would respond to international price signals. From the 1960s the government's production strategy was focused on the private sector. The public sector was largely limited to providing infrastructure. Perhaps most importantly in contrast to countries that have not grown rapidly, prudent fiscal and monetary policies laid a basis of macroeconomic stability and for growth. The share of government revenue in GDP increased substantially in the late 1980s, but government expenditure was restricted to ensure stability. This created public investment problems. Tax reforms consequently became a major issue, but in the light of the international debate that placed a high value on avoiding tax increases, the emphasis was on a tax structure that would improve tax efficiency and contribute to greater international competitiveness. This study grew out of that debate. It analyses the economic impact of tax reforms on resource allocation and utilisation. A static computable short run general equilibrium model was constructed to capture the principal Sectoral linkages - notably relative output prices and intersectoral and wage rate linkages - involved. The model contains a real sector and a linkage to the government budget. The model developed is of the ORANI type; it is linear in percentage changes. Euler's methodology was adopted to reduce the linearisation error. International trade tax and domestic sales tax reforms were investigated. An equal yield equilibrium approach was used to evaluate the 'differential incidence' of alternative tax policies. The value added tax (V AT) was chosen to introduce both reforms. The V AT rate was determined endogenously to n1aintain constant real government revenue. With a constant employment assumption, achieved by real wage flexibility, the empirical results show that an efficiency gain can be obtained with tariff liberalisation. Exports are able to grow. The resource allocation effects indicate that the importable and non-tradeable sectors are worse off, but the exportable sectors are better off. The simulation results for domestic sales tax reform show that nontradeable sectors lose while agriculture and manufacture are better off. Such a reform induces an improvement in the competitiveness of the exports. With a fixed real wage assumption, both reforms indicated efficiency losses because an introduction of the VAT caused an increase in the consumer price index (CPI) which was followed by an increase in nominal wage rates in the same percentage. The agricultural and non-tradeable sectors, in .which structure of production relied mainly on labour, were adversely affected. This implied that the negative wage linkage effects were stronger than the positive output price effects occurring as agriculture was exelnpted from the V AT. With the trade liberalisation, exports rise by 2 per cent, but with the domestic sales tax reform exports drop slightly because of an increase in the costs of production. The two assumptions used in the model thus result in different outcomes; a flexible real wage assumption seems to be more appropriate in Thailand which lacks union induced rigidities and unemployment benefits. Without a welfare system in place, high participation in the workforce is essential to survival.