WfF 24 V, POLICY RESEARCH WORKING PAPER 2442 A Firm's-Eye View of Policy In Cameroon, neither a major devaluation nor a major and Fiscal Reforms in simplification of the tax Cam eroon structure systematically affected profit margins. But trade liberalization- Bernard Gauthier substantial tariff reductions- Isidro Soloaga clearly signaled change to James Tybout manufacturers. And devaluation shifted relative prices dramatically in favor of exportable goods. The World Bank Development Research Group Trade September 2000 Po(lIY RESEARCH WORKING PAPER 2442 Summary findings After decades of heavy trade restrictions, fiscal They address each of these questions using a cost distortions, and currency overvaluation, Cameroon function decomposition applied to detailed firm-level implemented important commercial and fiscal policy panel data. reforms. Almost simultaneously, a major CFA They observe that Cameroon's reforms appear to have devaluation cut the international price of Cameroon's sent clear new signals to manufacturers, as the effective currency in half. rate of protection fell by between 80 and 120 percentage Gauthier, Soloaga, and Tybout examine the effects of points. these reforms on the incentive structure that Unlike trade liberalization, neither tax reforms nor the manufacturing firms face. Did they create a coherent set CFA devaluation had a major systematic effect on profit of new signals? Was the net effect to stimulate the margins. But the CFA devaluation did twist relative production of tradable goods? Was the dispersion of tax prices dramatically in favor of exportable goods, so burdens lessened? export-oriented firms exhibited rapid output growth. This paper-a product of Trade, Development Research Group-is part of a larger effort in the group to explore conceptual and practical issues in the trade policies of developing countries. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Lili Tabada, roorn MC3-333, telephone 202-473-6896, fax 202-522-1159, email address Itabada@aworldbank.org. Policy Research Working Papers are also posted on the Web at www.worldbank.org/research/workingpapers. The authors may be contacted at bernard.gauthier(q;hec.ca, isoloaga@worldbank.org, or jxt32Cwpsu.edu. September 2000. (35 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about developmetnt issues. An objective of the series is to get the findings out quickly, even if tle presentations are less than folly polished. 7he papers carry the names of the authors and should be cited accordingly. The finidings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the coun_tries thev represent. _ Produced by the Policy Research Dissemination Center A FIRM's-EYE Vucw OF POLICY AND FISCAL REFORMS IN CAMEROON Bernard Gauthier Ecole des Hautes Etudes Cornmerciales Isidro Soloaga lJniversity of Maryland James Tybout Pennsylvania State University We would like to thank Shanta Devarajaan, Mark Gersovitz, and Thomas McCool for helpful discussions, and Michel Sylvain for assis ance. This paper was funded by the World Bank and the Union Douaniere et Economique de l'Afiique Centrale (UDEAC). 1. Overview Upon gaining independence in 1960, Cameroon adopted an interventionist approach to industrialization and development. Its commercial policies kept import prices high, while its tax code selectively promoted certain firms and penalized others. These policies continued into the late 1980s and early 1990s, when the distortions they created were compounded by significant currency overvaluation in the CFA (Communaute Financiere Africaine) 2one, of which Cameroon is a member. Finally, in the face of crisis, the CFA countries agreed to devalue in 1994. Almost simultaneously, Cameroon implemented significant commercial policy reforms and attempted to level the playing field by reducing tax system inequalities. This paper examines the effects of these reforms on the incentive structure faced by manufacturing firms. Did they create a coherent new set of signals? Was their net effect to stimulate the production of tradable goods? Was dispersion in tax burdens lessened? We address each of these questions using annual survey data collected by the Regional Program on Enterprise DevAlopment (RPED), along with product-specific prices and quantities subsequently collected from a subset of the RPED sample.' The strength of our analysis l.es in the information at our disposal. For each type of tax and tariff, the firms in our sample reported the amounts they paid before and after the reforms. Further, because we re-visited the sample firms to collect price and quantity information on their major inputs and1 outputs, we are able to impute the effects of tariffs Further details on the RPED surveys n Cameroon may be found in Gauthier (1995). Information on the follow-up surveys is provided in l'ybout et al (1997). 2 on input prices from official tariff schedules for firms that that did not directly import the intermediate goods they used. We are also able to gauge the relative importance of each input and output to each producer. In sum, the data provide a far more detailed basis for inference than is typically available. 2 To organize our analysis, we use a cost function decomposition. Fiscal and commercial policy reforms are treated as influencing the effective prices of inputs and outputs faced by firns; their net effects are then calculated in terms of the changes they induced in costs per unit revenue, firm by firm. Assuming that international trade determines the border prices of all inputs and outputs, our calculations capture all the effects of Cameroon's fiscal and commercial policy reforms on the incentive structure and firms' gross profit margins.3 By using a cost function approach rather than input-output tables, we allow for the possibility that firms are able to substitute away from inputs that become relatively expensive, and toward inputs that become relatively cheap. Similarly, intra-firm substitutions among final products are recognized. Our effective protection figures therefore give a better measure of the true burden on producers than the traditional calculations (see footnote 2). 2 Standard effective protection measures are based on input-output matrices at the 2-digit or 3-digit level, in combination with tariff schedules or international price comparisons (e.g., Balassa, 1965). Many examples of this type of calculation and further references can be found in the seven volumes of country studies produced for the World Bank's 'Liberalizing Foreign Trade" project. Michaley, et al (1991) summarize the main findings. 3 If this assumption is too strong, our calculations isolate only the direct effects of policy reforms on after-tax, after-tariff prices of inputs and outputs. The general equilibrium effects of the reforms on pre-tax, pre-tariff prices are not ignored; they are lumped in with all other residual factors, such as the exchange rate, that affect relative prices. 3 The paper is organized as follows. Section 2 describes the fiscal and commercial policy regimes before and after the reform of 1994. Section 3 attempts to quantify the effects of the commercial and policy reforms on the firms' unit costs from a firm-level perspective. Section 4 introduces the data used in this paper, which are based on surveys spanning the 1992/95 period. Section 5 presents our findings on the sources of change in unit costs, and their relation to policy Section 6 summarizes and concludes. 2. Tax and Commercial Policy Reforms Until 1994, the Cameroonian government relied heavily on selective tax and tariff exemptions to promote industrial development. This strategy began in 1960 when the country enacted an Investment Code to attract foreign capital and encourage import- substituting industrialization. It was a.so shaped by the 1964 Treaty of Brazzaville, which dictated a number of taxes and duties to be implemented in all UDEAC countries.4 Subsequent to these events, the Camreroonian government layered on additional special tax schemes and exemptions. The cumulative effect was to create one of the most complex and unfair systems of taxes and duties in Sub-Saharan Africa. Under this pre-reform regime, firms that did not enjoy access to any of the special programs'-UDEAC-wide or Cameroonian-were subject to a variety of direct and sales taxes. Further, those that imported irLtermediate goods were subject to four tariffs unless they had special status. The overall :ariff structure was highly diversified, with rates 4 ranging from 0 percent to 500 percent (World Bank, 1995, Appendix 6). The regime not only encouraged evasion, it also provided considerable incentives for firms to seek special treatment from the tax authorities. Such treatment was available to manufacturers through a variety of mechanisms on a case-by-case basis. Appendix 1 provides details on the direct and indirect taxes, tariffs, and special programs that prevailed in the pre-reform period. In January 1994, the government began to dismantle this system. In several decrees, it attempted to correct anti-trade biases by increasing the importance of domestic taxes and reducing tariffs. It also attempted to reduce inequalities, distortions, corruption a.mong administrators, and incentives for evasion.5 These reforms were motivated by several objectives: (1) to comply with conditionality in a World Bank Structural Adjustment Program; (2) to further the UDEAC objective of promoting regional economic integration; and (3) to shore up tax revenues, which had been eroding as oil exports fell and tax exemptions and evasion became increasingly prevalent.6 The new policy regime included several components that affected external trade: a) The four-types of tariffs were replaced by a unified single system known as the TEC (Tarif extirieur commun), applicable to imports from non-UDEAC countries. 4 UDEAC, the Union Douaniere et Economique de l'Afrique Centrale, is composed of Cameroon, the Central African Republic, Chad, Congo, Equatorial Guinea and Gabon . It was formed in 1964 by the Treaty of Brazzaville. 5. In 1994, more than 50 percent of the 200 finns interviewed in the RPED sample said they had not paid their full tax obligations in the previous fiscal year. 6 Tax revenues in 1992 amounted to only 12.3 percent of GDP, comapred to a median of 18.5 percent for other Sub-Saharan African countries (World Bank, 1994, table A.2.) 5 b) Imports were classified into four categories, with tariff rates ranging from S percent to 30 percent, compared with rate, ranging from 0 percent to 500 percent under the previous system. c) A general preferential tariff was introducedfor trade between UDEAC countries, with an initial rate fixed at 20 perc,ent of the applicable TEC.' Further, the reform essentially replace4d the various sales taxes with a value-added tax and eliminated most special privileges. (Appendix 1 provides details.) Table 1: Coyverage of Special Regimes 1992-93 1993-94 1994-95 Percentage offirms enjoying at leest 64.8% (83) 60.9% (78) 14.1% (18) one special tax regime* Privilegedfirms' sales as a 98.5% 94.4% 29.5% percentage of total sales Privilegedfirms' imports as a 99.1% 98.2% 74.0% percentage of total imports *The number of firms in each category is given in parentheses. The total number of firms = 128 Table 1 documents the coverage of special fiscal regimes within the RPED sample before and after the reforms. Note tkat the proportion of manufacturing enterprises enjoying fiscal privileges dropped fiom 64.8 percent to 14 percent over the two year period, and the phase-out of privilegres was equally dramatic when measured in terms of sales. However, most of the major i]nporting firms continued to enjoy special privileges after the reforms. Special regimes a)plied to 99 percent of the total value of sample imports in 1992-93, and still applied to 74 percent in 1994-95. This pattern reflects the This rate was to be reduced to 10 percent on January 1 1996 and 0 percent on January 1 1998. 6 fact the major importers in Cameroon are large, and large firms continued receiving privileges in 1994-1995. If the reforms had bite, many firms that enjoyed special status in 1992-93 should have borne a larger tax burden in 1994-95. To quantify this effect, Table 2 presents the tax rates firms reported facing in each fiscal year. The firms are grouped as follows: those in special programs (who lost most of their benefits), those with free trade zone status or ad hoc agreements (some of whom retained their benefits), and firms operating under the common law regime in 1992-93. Table 2: Average Indirect Tax Rates for Different Categories of Firms based on their 1992-93 Status* 1992-93 1993-94 1994-95 - ~ - Sales Taxes Privilegedfirms * Special incentive programs (UDEAC and 8.4% 8.3% 14.9% Cameroon) * Free trade zone or ad hoc agreements 10.9% 8.7% 16.5% No privileges 10.3% 10.7% 16.0% Privilegedfirms * Specialincentiveprograms(UDEACand 15.8% 17.8% 19.8% Cameroon) * Free trade zone or ad hoc agreements 18.5% .. 30.0% No privileges 66.8% 52.4% 20.2% * The total number of firms is 128. Figures in parentheses are averages of 1994/95 sales taxes (TCA) weighted by the ratio of value-added to total sales, firrn by firm. 7 Firns with special incentive programs in 1992-93 reported that they faced an average sales tax rate of 8.4 percent in that year. However, in 1994/95 they were confronted with an average quasi-value-added tax of 14.9 percent. Similar patterns emerge for the free trade zone/ad hoc agreement group and the unprivileged group, although their rates are generally not as favorable as those of the special program firms. Therefore, although they saw their sales tax rates increase, the special program group continually enjoyed a discount of several percentage points, and there was no obvious tendency for this group to converge toward the others. (Whether the effective tax burden increased or decreased must be analyzed in conjunction with figures on value-added, and this will be done in the following section.) With respect to customs, the rates faced by the firms that originally enjoyed special programs increased from 15.S percent in 1992-93 to 19.8 percent in 1994-95 as privileges were phased out. The free trade zone firms and firms with ad hoc arrangements faced an even greater increase, with rates jumping from 18.5 percent to an average of 30 percent. This reflects the fact that mDre than half the sample firms under these regimes lost their privileges after 1992-93. Finally, for firms operating under the normal regime in 1992-93, the impact of the reform was major. Their customs rates fell from 66.8 percent in 1992-93 to an average of 20.2 percent in 1994-95. Thus there is some evidence that the tariff reforms tended to level the playing field. 3. Quantifying the Effects of Commercial Policy and Fiscal Reforms Tables 1 and 2 demonstrate that the reforms did indeed change the level and distribution of the tax burden. However, they do not document the combined effects of 8 these reforms on after-tax costs per unit revenue for individual firms. This is our next objective. As in Tybout et al (1997), we begin with a cost function: (1) C = f(Q,PL,P,,PK,A) Here C is the minimum attainable cost at output level Q, productivity level A, and the vector of effective (after tax, after tariff) prices for intermediate goods, P, labor, P,, and capital, PK. By Shepard's lemma, we have: (2) d)nC=(d)dInQ+s(dInP)+SL(dInPL)+SK(dln.P)+ (m A dlnA, where 1l is the elasticity of output with respect to cost, or returns to scale. Normalizing by the value of output, we obtain a decomposition of the sources of growth in cost per unit revenue: dIn C- d l(QPQ)= (n -l)dlnQ+s1(dlnP1 - dlnPQ)+sL(dInPL -dln6Q) (3) - i9 I~~~~~eYn A) + SK(d In PK - d In PQ ) + ( a1id In A A second-order Tomqvist approximation to this expression in discrete time is given by: AlnC-Aln(QPQ)= (-l)AlnQ+s(AlnPI -AInPQ)+s (AlnP -ALn PQ) (4) ħs,(lnPnC ln SK(A In PK-AlnPQ)+(dnA dInA where A is the difference operator for period t versus t-l and overbars denote cross-period averages of the associated variable. 9 Commercial policy affects costs per unit revenue by changing the after-tariff prices of inputs and outputs. Domes :ic tax policy similarly affects input and output prices net of taxes, and may further change after-tax costs through lump sum taxes such as the patente (see Appendix 1). The ba.ance of this paper is devoted to quantifying these channels of transmission from policy reforms to the incentive structure at the firm level. It is possible that commercial and domestic tax policy affect the efficiency parameter, A. Similarly, if there are scale economies, they may affect unit costs by changing the volume of output.8 However these channels of transmission are empirically intractable, and we will not attempt to measure them separately. Linking prices to policy. Let us suppose for the moment that every good used or produced by Cameroon firms is also available in foreign markets, and that arbitrage between domestic and foreign goocds is perfect. It is then straightforward to calculate the effects of the fiscal and commercil policy on the after-tax, after-tariff prices faced by producers. Specifically, under the pre-reform regime, directly imported inputs were subject to tariffs but not to sales taxes (t), while domestically produced inputs were subject to sales taxes but not to tariffs. Vith perfect arbitrage, Cameroon firms paid P1i = Pli(l + t) = P,(I + aii ) for the ith input, where P,i is the external price of this input, P,i is the pre-tax price of the domestically produced version of input i, r,l is the tariff 8 Head and Reis (1999) provide a recmt survey of the theoretical channels through which commercial policy can affect scale efficiency. 10 rate, and t is the sales tax rate. Analogously, after taxes, a Cameroon producer of the jth output received P,= = PJ (1 + r, )/ (1 +t) per unit produced. When Cameroon moved to a value-added tax, domestic and foreign purchases of the ith input were effectively tax-free (albeit not tariff-free) because the value-added taxes paid on these purchases were rebated. But perfect arbitrage implies that the price of domestic inputs still matched the tariff-distorted world price: P1i = PJ, (1+ ri). Hence, under the perfect arbitrage assumption, Cameroon's fiscal and commercial policy reforms influenced input prices only by affecting tariff rates. On the other hand, in the product markets, the new regime meant that Cameroon firms collected the tariff-distorted world price adjusted upward by the value-added tax rate (v), P., (1 + t) = P* (1 + r, )(I + v), and they kept PQ, =P*(+r). So under the perfect arbitrage assumption, moving to a value-added system increased the after-tax price of outputs relative to inputs by eliminating the cascading effect of sales taxes. Of course, perfect arbitrage is not a realistic assumption for most products. Transaction costs and product differentiation will typically allow domestic and foreign varieties of the same good to exhibit different prices, and the response of these prices to changes in commercial policy and the fiscal regime will doubtless depend on market of origin. To deal properly with these problems, an extremely detailed computable general equilibrium (CGE) model would be needed. No such models exist for Cameroon, nor is it feasible to construct one. 11 Because the general equilibri um effects are too complex to disentangle, we isolate the discrepancy between domestic arid foreign prices in the endogenous scaling variables, Ah, and 2A,, which apply to the ith input and thejth output, respectively. Accordingly, the effective price of the ith domestic input is P, = PI, A ,, (I + T ji ) and the price of thejth domestically produced output is eithzr PQ APQ(1 + T0 ) /(1+t) or PQ1 = A Q,P* (1 + rZ ), depending on whether the old or the new regime is in force. These relationships are summarized in Table 3 below. Table 3: Producer Prices (P,, PQ) Under Alternative Regimes Type of good Market source/ Perfect Arbitrage Imperfect Arbitrage: Destination Sales Tax Regime Inputs (P,): imported P* (1 + T ) P* (1 + a ) domestic PI = PI (I + r) P , P*(1 + r) Outputs(PQ,) PQ = PQ(1+ rQ)1/(1 +t) PQ =AQP* (I+ TQ)/(1+ t) VAT Regime Inputs (p,): imported P;(1+ I-) P;(1 + ) domestic PI P;*(1 +r) PI =AIP;*(1 + Z) Outputs (PQ) PQ - P(1+ rQ) PQ =AQPQ(l+TQ) Before we substitute these producer prices back into equation 4, we must deal with the fact that firms use multiple inputs and produce multiple outputs. To this end, we 12 use Tornqvist indices of the growth rates in effective input and output prices, which amount to share-weighted aggregations of the growth rates in the prices of the individual goods. Specifically, for intermediate inputs, we calculate N ~~N N N A PI =siAlnPi, XsiAAln(PE)+ siAln(I+ rT1)+ s1Aln2(i,) i=l 1=1 i=l j=1 (5) = AlnPi* +Aln(l+ r,)+Aln(A,) where s, is the share of expenditures on the ith input (inclusive of tariffs) in total intermediate input costs, averaged across periods. Given that producers report prices paid inclusive of tariffs, as well as tariffs paid, we observe both Pn 's and r,, 's, so the left- hand side and the tariff component of the right-hand side can be isolated. However, we do not have micro data on the external prices of each product, so we cannot disaggregate the sum A ln P* +A ln(, ) . Analogously, for effective output prices we write: (6). A ln(P-) = Aln(I + r) + Aln(P) - A)ln(l +t)+ Aln(A.) = ajA ln(I + ħQj) + EijiAln(PQj) - -ajAln(I + to) + SajAln(A ) j=l j=l j=1 j=1 It should be remembered from Table 3 that the sales tax is phased out between the initial and the final period, so Aln(l+tQ)amounts to -ln(lIt4), where t' is the pre-reform sales tax rate. Also, as with effective input prices, note that we will be unable to distinguish the effects of imperfect arbitrage from the effects of changes in external prices. 13 A generalized cost decomposition. Substituting these relative price expressions into our unit cost decomposition (4) and writing costs and revenues as net of taxes, we obtain: (7) AInC- AIn(Qj)= (,- 1-)AInQ+ EdlnC) A) A +s,1ln(I+r,)-A1n(l+rQ) + A ln(1 + tQ) + s, [A In(P, 2A) - A In(PjAQ)I + s, [A In PL - A In(PjAQ)] +sK[A ln(PK) - A In(PjAQ)] Here, the first line on the right-hand side reflects the scale and other efficiency effects that we will treat as a residual; the second line reflects the direct effects of commercial policy on unit costs, the third line reflects the direct effect of eliminating sales taxes, and the last two lines reflect the change, in relative prices not directly related to commercial policy or taxes. Of course, the general equilibrium effects of these policy changes come partly through ARI, AQ, PL and PK--We are unable to isolate these indirect effects. Note also that under the perfect arbitrage assumption, these last lines simply pick up changes in wages and world prices. Since we are unable to observe effective prices for capital services directly, we will henceforth assume that they grow at the same rate as the pre-tariff rate of growth in domestic output prices, A ln(P(2AQ). The last line then becomes a wage effect alone: 14 (7') AInC-Aln(QP)= (. -1)AlnQ +( lnC) Aln A (residual efficiency effect) +s1, A In(I + r, ) -A In(I + TQ) (effective protection effect) + A ln(l + to) (tax reform effect) + s, [A In(P, i,) - A ln(PQA,)] (relativepre - taxprice effect) + s [A In P,. - A ln(PQ2Q)] (relative cost of labor effect) Relation to Effective Protection Measures. The above formula is useful for calculating levels of protection as well as growth rates. These can be obtained by setting all initial protection rates to zero and measuring the increase in cost when actual protection rates are imposed. However, to do this, it must be assumed that i, = AQ= 1, and some assumptions must also be made about the expenditure shares that would have prevailed if producers had faced zero tariffs. One possibility is to assume that the elasticity of substitution among all intermediate inputs is unity. Then the same shares prevail with and without tariffs, and the tariff effect in second line of equation (7') becomes approximately N - = - Es .9 This expression is a variant of the standard effective i=1 protection measure when expressed as a ratio to value-added per unit revenue: N TQ- r, . The most common alternative approach is to presume there are no 1-Es i=l substitution possibilities at all among intermediate inputs. Then the translog cost function 9 This follows because ln(I +x) _ x for small x values. 15 is a poor approximation to technology, and effective protection calculations are best done using input shares based on internatioaal prices. Lump-sum Taxes. Finally, we must adjust our formula to account for lump-sum business taxes. Denoting these taxes by T, we write costs inclusive of lump-sum taxes as C = C + T. Our final and most general forn of the decomposition is then: (8) Aln(C )-Aln(QPQ)=O[Aln(C)-AIn(QPQ)] + (I1- @)[A ln( ) - A ln(QP59)] where 9 = C is the share of costs before lump-sum taxes in total costs, and an C+_T overbar denotes the cross-period aveiage. The first right-hand term is simply equation 7 weighted by 9, and the second term picks up the effect of growth in lump sum taxes relative to growth in net revenue. 4. The Data Data on costs, sales, taxes, tariffs and other variables were collected from roughly 200 Cameroon firms for the fiscal years 1992-93 and 1994-95. However, these surveys did not collect information on the prices of inputs and outputs. Hence, as part of a recently completed project, roughly 80 firms in the RPED data base were re-visited and asked for recall information on the values and quantities of their five major inputs and five major outputs in both fiscal years. Only a subset of 37 firms was able to supply complete and credible information; we will henceforth refer to this sub-sample as the "re- surveyed" firms. 16 Using this sub-sample, we constructed unit prices for each product by dividing the value of production by the number of units produced. For example, indexing products by j, we obtained P, = Vj, / Qjt, j = 1, J. Intermediate input prices and the cost of labor were imputed analogously. The prices were reported inclusive of tariffs and sales taxes, so they correspond to the P., and Pfi concepts described above. Tariff data reported by the firms were augmented with official tariff information by product line obtained from the Cameroon government. Hence, we were able to impute A ln(A2P ) and A In(21P, ) using the identities. 10 Finally, with these building blocks, we were able to solve for the residual scale economy and productivity effect, I- )A In Q + ln C AIn A. For the purpose of variable construction, tariffs ( r ) before the reform were composed of the four types of tariffs (DD, DE, TCAI and TC) for firms operating under the normal regime, and of the TU or TIP applicable to imports for firms receiving special privileges. After the reform, tariffs ( r ) included the TEC or TPG. On the other hand, tax burdens (t) included the ICAI for firms operating under the normal regime before the reform and the TU or TIP applicable to local sales for firms operating under a special regime. After the reform, the indirect tax burden is composed of the TCA. Further discussion of the data may be found in Tybout et al (1997). 0 An interesting extension would be to exploit data on international prices and isolate growth in X's from growth in P 's. 17 5. Basic Findings: Pooled Sample Turning to our findings, let us begin with an overview of the magnitudes of the different shocks to unit cost. Equation (7') provides the relevant decomposition; it is empirically rendered in Table 4. The general pattern: For the pooled sample, the increase in unit costs was roughly 8.5 percent. This reflected a substantial increase of 20.2 percent due to commercial policy reforms, partially offset by residual productivity improvements of 15.2 percent. The dominant shock the producers faced was therefore trade liberalization, and this was partly offset by productivity improvements. The productivity gains were not due to scale effects or improved capacity utilization, on average, because real output did not grow in the typical firm. (The fact that output did not shrink is surprising, given the extent of the profit margin squeeze endured by -he firms.) Instead, as we have argued elsewhere, improved efficiency of input use appears to be part of the story (Tybout et al, 1997). The effect of trade liberalization is strong because the average nominal tariff rate on outputs in our sample fell from 68 percent to 27 percent, while the average nominal tariff rate on inputs fell from 21 percent to 17 percent. In other words, most of the reduction in protection affected products that the sample firms sold rather than those they bought. This liberalization effect is also apparent in Table 7, where it can be seen that traditional effective protection measures fell on average between 80 and 120 percentage 18 points, depending on whether all inputs and outputs are treated as perfectly tradable (upper panel), or whether non-imported inputs are treated as non-tradable (lower panel)." Table 7 also reveals that the amount of cross-firm dispersion in effective protection dropped dramatically with the reforms, as intended. This leveling of the playing field was largely due to the elimination of special exemptions, as discussed in section 2 above. One issue that often arises in Africa is whether the reforms worked at cross purposes. In the present context, it is interesting to ask whether the tax reform and the exchange rate devaluation undid the strong signal sent by the commercial policy reforms. The answer is that on average they did not. The tax reforms actually further increased unit costs, although their 2.6 percent effect was modest in comparison with that of the commercial policy reforms. The reason it was not greater is that most of the pre-reform fiscal privileges took the form of tariff reductions, which have continued to be the government's primary source of revenue. If the CFA devaluation had systematically raised or lowered firmns' gross margins, this would have been seen under "other relative price effects." On average, however, this type of shock had almost no effect: manufacturing activities were neither hurt nor helped on average. The notion that devaluation eased the pain of trade liberalization is therefore These figures are not "traditional" in the sense that firm-specific input shares are used, rather than an economy-wide input-output table. In keeping with convention, these figures describe the percentage change in value-added (rather than the percentage change in cost per unit revenue), so neither set of calculations is directly comparable to the fourth column of Table 4. Specifically, the percentage change in costs due to tariff reforms has been divided by the share of value-added in gross output. 19 not supported by our findings. Nonetheless, the real devaluation did considerably change the returns to tradable versus non-tradable goods production, as we will discuss shortly. Simple averages across firms are sensitive to outliers, and assign disproportionate weight to small firms. Accordingly, we also examined output-weighted averages and medians to determine whether these basic results are robust. The results, reported in Tables 5 and 6, confirm that the commercial policy, tax policy, relative price and residual productivity figures remain very similar when we use medians, although the median output growth is -10.3 percent. Output-weighted figures produce a similar picture, although the they exhibit cost-increasing relative price effects (10.3 percent), offset by larger residual productivity growth (23.5 percent). 6. Dissaggregated Findings Exporters vs. Non-exporters: Breakdowns by sector reveal that, on average, firms that were exporting in 1992-93 repor:ed relatively modest unit cost growth (6.1 percent compared to 9.7 percent for non exporters), even though the direct effects of the commercial policy reforms were mowe favorable to non-exporters. The exporters gained ground mainly because relative price effects reduced their unit costs by 10.9 percent, while they increased unit costs for non-exporter by 6.4 percent. This probably reflected the 100 percent CFAF devaluation against the French Franc that took place between the sample years, and possibly also some general equilibrium effects on export prices due to the commercial policy reforms. If we divide the firms according to whether they exported in 1994/95, the contrast is more dramatic. Exporters registered a unit cost growth of only 2.3 percent, compared 20 with 13.3 percent for non-exporters. Furthermore, 1994/95 exporters showed a productivity increase of 27.4 percent and an output growth of 21.2 percent. Hence, only firms that exported under the new regime showed unusually rapid output and productivity growth. Qualitatively, the same picture emerges from output-weighted averages and medians, although the results on productivity growth vary with the type of summary statistic. The fact that firms exporting at the end of the sample period did better than firms exporting at the beginning of the sample period probably reflects self-selection effects. Firms that experienced cost reductions tended to begin exporting, and those that experienced cost increases tended to cease (Clerides, et al, 1998). It also suggests that the pre-reform incentive structure induced a number of firms to export products that were not to the country's comparative advantage. Imported Input-intensive Firms: Producers who relied fairly heavily on imported inputs fared better than those that did not, although the contrast was not dramatic. As one might expect, this difference is partly attributable to the fact that the former group was hurt less by the commercial policy reforms. One reason we do not record larger disparities is simply that the net tariff effect presumes perfect arbitrage between domestic and imported inputs. Hence, regardless of whether firmns actually imported their inputs, they are assumed to benefit equally from liberalization-induced price reductions.'2 The output-weighted figures tell a different story than the unweighted means about the relative performances of the two sets of firms. They show larger cost increases 12 If there is imperfect substitutabi I ity between domestically produced and imported intermediates, this should show up in other relative price effects. But these price effects also favored firms that relied on 21 for import-intensive producers, and smaller cost increases for domestic input-intensive producers. However, the contrast does not trace to direct commercial policy or fiscal policy effects. It is due to other relative price effects, which are sensitive to whether averages are weighted because large import-intensive firms experienced major adverse shocks. Sector-based Breakdowns. In terms of sectors, wood sector firns, on average, recorded a larger unit cost growth, with a 23 percent increase. This finding traces to a large commercial policy-based reduc:ion in output prices, which more than offset the relatively large improvements in pre-tariff relative prices and relatively small domestic tax effects. Output-weighted averages and median figures reveal that larger wood sector firms fared better than smaller ones, making sector-wide output growth positive. In the food sector, weighted averages and median figures indicate that larger food sector firms endured a substantial increase in unit costs. Despite a smaller commercial policy impact on the food sector and larger productivity gains than in other sectors, it was hit more severely by (pre-tariff) rela Live price effects, which increased unit costs by 39.9% (output-weighted). Textiles and metal products experienced relatively modest cost increases, despite substantial reductions in protection, partly because they realized large productivity gains. (See Table 7.) domestic inputs over those that were import-intensive, suggesting that other factors are at work as well. 22 7. Summary and Conclusions To summarize, we have quantified several basic changes in the incentive structure that resulted when a maxi-devaluation was accompanied by substantial tariff reductions and a major simplification in the tax structure. First, the combined effect of these changes in the economic enviromnent was to increase costs per unit revenue by 20 percent at the median firm, and by 9 percent on average. This constitutes a major change in the return to manufacturing activities, and it is somewhat remarkable that output did not contract. Second, the dominant force behind these reductions in gross profit margins was a substantial drop in the rate of nominal protection for firns' final products. Since protection levels on imported intermediate goods were relatively modest before the reforns, unifying the tariff structure mainly meant bringing down tariffs on final goods, thereby reducing effective protection rates by somewhere between 80 and 120 percentage points. The cross-firm dispersion in effective protection rates also fell markedly. Accordingly, despite the presence of other shocks, Cameroon's trade reforms appear to have created clear new signals for manufacturers. Third, substantial productivity growth cushioned the effects of the trade liberalization on profit margins. The unweighted average rate of productivity growth was 15.2 percent in the pooled sample, and the weighted average was 23.5 percent. As we have documented elsewhere, at least part of the explanation seems to be that firms economized on intermediate inputs (Tybout et al, 1997). In contrast to trade liberalization, neither the tax reforms nor the CFA devaluation had a major systematic effect on profit margins. For most firms, the new tax code 23 increased after-tax costs per unit revenue by several percentage points, and the changes in relative prices not directly linked to taxes or tariffs had an even smaller net effect for the average firm. Nonetheless, the CFA devaluation did twist relative prices dramatically in favor of exportable goods, and firms that directed their output toward foreign markets exhibited relatively rapid output growh. Here too, then, the intended shift in incentives clearly registered at the ground level. Overall, our firm-level panel data have allowed us to measure the effects of the policy reforms on different types of firms with considerably more precision and detail than aggregate data afford. Accordingly, we hope that this study provide a useful methodological example for researchers and policy makers concerned with the consequences of related reform packages elsewhere. 24 Table 4: Commercial Policy, Tax Reform, and Unit Production Costs (Equation 7) Unweighted Averages net unit tar iff effect, tariff effect, effective Other residual domestic real output cost outputs inputs protection relative productivity tax growth Industry growth (i) (ii effect price effects effects (i)+(ii) effects Food 0.094 0.172 ~~~~~~~~---0.026 0.146 0.113 -0Z.189 0059.4 Textiles 0.029 0.243 0.008 0.250 -0.089 -0.161 0.029 0.219 wood products 0.230 0.355 0.000 0.355 -0.084 -0.049 0.007 0.004 metal products 0.063 0.216 -0.017 0.179 -0.027 -0.125 0.035 -0.335 Domestic Input 0.104 0.238 -0.005 0.232 -0.062 -0.088 0.022 0.192 Intensive Imported Input 0.067 0.202 -0.030 0.173 0.076 -0.212 0.030 -0.200 Intensive uNon-Exporters 92- 0.097 0.209 -0.02 1 0.188 0.064 -0.177 0.020 0.053 93 Exporters 92-93 0.061 0.241 -0.010 0.230 -0.109 -0.100 0.039 -0.139 Non-Exporters 94-95 0.133 -0.198 -0.019 0.179 -0.011 -0.058 0.025 -0.177 Exporters 94-95 0.023 -0.249 -0.016 0.233 0.035 -0.274 0.029 0.212 Small 0.053 0.239 -0.020 0.219 0.024 -0.210 0.021 0.084 Medium 0.064 0.201 -0.016 0.185 -0.038 -0.113 0.031 -0.103 Large 0.185 0.208 -0.016 0.193 0.047 -0.086 0.031 -0.066 Total 0.085 0.220 -0.017 0.202 0.009 -0.152 0.027 -0.009 25 Table 5: Commercial Policy, Tax Reform, and Unit Production Costs (Equation 7) Output Weighted Averages net unit tarif effect, Tariff effective Other residual domestic real output cost outputs effect, protection relative productivity tax growth Industry growth (i) inputs effect price effects effects (iiJ ()+(i)i) effe ts Food -0.291 0.172 -0.043 0.129 0.399 -0.262 0.025 0.090 Textiles -0.070 0.269 0.009 0.278 -0.110 -0.258 0.021 0.133 woodproducts 0.080 0.355 0.000 0.355 -0.107 -0.177 0.008 0.091 metalproducts 0.018 0.378 -0.011 0.367 -0.244 -0.135 0.030 -0.242 Domestic Input 0.009 0.264 -0.017 0.247 -0.092 -0.171 0.025 0.216 Intensive Imported Input 0.198 0.231 -0.021 0.210 0.246 -0.283 0.024 -0.093 Intensive Non-Exporters 92-93 0.249 0.118 -0.038 0.080 0.548 -0.396 0.016 0.140 Exporters 92-93 0.049 0.312 -0.010 0.302 -0.131 -0.151 0.029 -0.015 Non-Exporters 94-95 0.253 0.125 -0.035 0.091 0.108 0.021 0.033 -0.196 Exporters 94-95 0.080 0.278 -0.015 0.026 0.101 -0.306 0.022 0.103 Small 0.204 0.175 -0.038 0.137 0.165 -0.128 0.030 -0.261 Medium 0.137 0.191 -0.016 0.175 0.389 -0.447 0.021 0.171 Large 0.103 0.277 -0.020 0.257 -0.049 -0.131 0.026 -0.015 Total 0.118 0.245 -0.020 0.226 0.103 -0.235 0.025 0.038 26 Table 6: Commercial Policy, Tax Reform, and Unit Production Costs (Equation 7) Medians net unit tariff effect, tariffeffect, effective other residual domestic real output cost outputs inputs protection relative productivity tax growth Industry growth (i) (ii) effect price effects effects (i)+(ii) effects Food 0.336 0.203 -0.012 0.148 0.115 0.046 0.011 -0.103 Textiles 0.143 0.244 0.000 0.244 -0.052 -0.248 0.027 0.117 woodproducts 0.130 0.356 0.000 0.356 -0.081 -0.176 0.000 0.032 metalproducts 0.205 0.213 -0.030 0.180 -0.012 -0.144 0.024 -0.315 Domestic Input 0.156 0.244 -0.000 0.238 -0.029 -0.187 0.009 0.083 Intensive Imported Input 0.278 0.215 -0.020 0.213 0.147 -0.030 0.018 -0.313 Intensive Non-Exporters 92-93 0.278 0.215 -0.008 0.215 0.079 -0.038 0.004 0.002 Exporters 92-93 0.022 0.271 -0.001 0.262 -0.157 -0.151 0.042 -0.151 Non-Exporters 94-95 0.324 0.215 -0.000 0.215 0.027 0.046 0.009 -0.298 Exporters 94-95 0.001 0.255 -0.012 0.254 0.026 -0.257 0.021 0.167 Small 0.205 0.233 0.000 0.215 0.030 -0.155 0.004 0.018 Medium 0.182 0.179 -0.013 0.186 -0.093 -0.094 0.017 -0.094 Large 0.259 0.243 -0.004 0.246 0.078 -0.117 0.027 -0.162 Total 0.205 0.233 -0.003 0.229 0.027 -0.144 0.011 -0.103 27 Table 7: Traditional Effective Rates of Protection Unweighted Averages and Standard Deviations Metal & Domestic Imported Wood Metal Non Input Input ALL Food Textile Product Product Exporters Exporter Intensive Intensive Small Medium Large Number offirms 34 14 9 4 7 24 10 18 16 16 11 7 Only imports Mean 1.6 1.46 1.83 2.27 1.18 1.58 1.65 1.73 1.45 1.84 1.6 1.04 ERP: Std. 0.9 0.94 1.01 0.5 0.64 0.87 1.02 0.7 1.08 0.79 1.06 0.69 92-93 Max. 4.02 3.2 4.02 2.88 2.21 3.2 4.02 3.2 4.02 3.2 4.02 2.45 Min. 0.22 0.22 0.7 1.79 0.45 0.22 0.7 0.7 0.22 0.22 0.52 0.3 Mean 0.59 0.68 0.51 0.8 0.42 0.69 0.37 0.73 0.45 0.78 0.4 0.46 ERP: Std. 0.34 0.4 0.26 0.17 0.27 0.34 0.19 0.33 0.28 0.36 0.26 0.08 94-95 Max. 1.69 1.69 0.94 1.01 0.79 1.69 0.66 1.69 1.2 1.69 0.96 0.59 Min. 0.1 0.23 0.1 0.63 0.11 0.23 0.1 0.31 0.1 0.23 0.1 0.37 All inputs as Mean 1.15 0.92 1.62 1.09 1.02 1.01 1.48 0.96 1.35 1.08 1.34 0.98 ERP: Std. 0.81 0.67 1.14 0.25 0.66 0.67 1.05 0.46 1.07 0.68 1.04 0.75 92-93 Max. 4.02 2.33 4.02 1.46 2.21 2.33 4.02 2.29 4.02 2.29 4.02 2.54 Min. 0.24 0.24 0.49 0.92 0.45 0.24 0.58 0.3 0.24 0.24 0.41 0.26 Mean 0.35 0.37 0.36 0.29 0.34 0.39 0.25 0.33 0.37 0.4 0.26 0.37 ERP: Std. 0.17 0.15 0.18 0.03 0.25 0.14 0.2 0.14 0.2 0.16 0.16 0.19 94-95 Max. 0.79 0.68 0.61 0.32 0.79 0.79 0.61 0.68 0.79 0.79 0.46 0.61 Min. 0.03 0.03 0.1 0.25 0.07 0.23 0.03 0.03 0.07 0.23 0.07 0.03 28 References Baldwin, Richard E. and Paul Krugman. 1989. "Persistent Trade Effects of Large Exchange Rate Changes." Quarterly Journal of Economics 104(4): 635-54. Balassa, Bela. 1965. "Tariff Protection in Industrial Countries: An Evaluation." Journal of Political Economy. 73(6): 573-94. Chamber, Robert G. 1988. Applied Production Analysis. New York: Cambridge University Press. Clerides, S.K., Lach, S. and Tybout, J. 1998. "Is learning by exporting important? Micro- dynamic evidencee from Colombia, Mexico and Morocco," Quarterly Journal of Economics 113(3): 903-947. Devarajan, Shanta. 1996. "How Overvalued was the CFA Franc? Estimates of Real Exchange Rate Misalignment with a Simple General Equilibrium Model." Processed. The World Bank, Washington, D.C. Dixit, Avinash. 1989. "Entry and Exit Decisions Under Uncertainty." Journal of Political Economy 97(3): 620-38 Gauthier, Bernard (ed.) 1995 "Economic Reform and the Development of the Manufacturing Sector in Cameroon", RPED Paper 44, The World Bank, Washington, D.C. Gauthier, Bernard and Mark Gersovitz. 1997. "Revenue Erosion Through Exemption and Evasion in Cameroon, 1993", Journal of Public Economics, 64(3): 407-424. Head, Keith and John Reis. 1999. "Rationalization Effects of Tariff Reductions," Journal of Intrenational Economics 47(2): 295-320. Hopenhayn, Hugo and Richard Rogerson. 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis." Journal of Political Economy 101: 915-938. Michaely, Michael, Demetris Papageorgiou, and Armeane Choksi. 1991. Liberalizing Foreign Trade: Lessons of Experience in the Developing World. Volume 7. Cambridge, MA: Basil-Blackwell for the World Bank. Sullivan, Theresa, James Tybout and Mark Roberts. 1995. "What Makes Exports Boom? Evidence from Plant-Level Panel Data," processed, The World Bank, Washington D.C. Tybout, James, Gauthier, Bernard; Barba Navaretti, Giorgio; de Melo, Jaime 1997, "Firm- Level Responses to the CFA Devaluation in Cameroon", Journal of African Economies, 6(1): 3-34. World Bank 1992. Regional Cooperation for Adjustment: A Program of Trade and Indirect Tax Policy Reforms for Member Countries of the Customs Union of Central African States (UDEAC). Report No.9747-AFR. Washington D.C.: The World Bank, Washington, D.C. World Bank. 1994. Adjustment in Africa: Reforms, Results and the Road Ahead. New York: Oxford University Press World Bank. 1995. Republic of Cameroon. The Challenge: Harnessing Unrealized Potential (A Private Sector Assessment Report No. 13955-CM, Washington, D.C. 30 APPENDIX Fiscal and commercial policy before 1994's Prior to 1994, firms that did not enjoy access to any of the special programs (UDEAC- wide or Cameroon) were subject to the following direct and indirect (sales) taxes: a) Impot sur le chiffre d'affaires interieur (ICAI): Businesses in all the UDEAC countries were subject to a domestic sales tax. The ICAI in Cameroon was generally levied at a rate of 10.9 percent on sales value, but a reduced rate of 4.5 percent and a special rate of 2.5 percent for bakeries also existed.'4 b) Impot sur les bngefices industriels et commerciaux (BIC) and Imp6t minimum forfaitaire (IMF): Cameroon businesses were also required to pay a company tax comprising the highest of the following taxes: (i) the BIC, a tax on profits imposed at a rate of 38.5 percent (including a 10 percent communal tax) for incorporated businesses and 24.2 percent for unincorporated businesses; (ii) a 1 percent tax on sales; and (iii) the IMF, a minimum presumptive tax."5 c) Contribution des patentes. In addition, Cameroon businesses were required to pay a patente, a kind of business license fee collected annually to help finance local governments. This tax was based on broad business activity indicators (output, equipment, number of employees). d) Impot special sur les societes: Cameroonian corporations were subject to a special tax on corporations, applied to capital at rates varying between 0.5 percent and 1.5 percent. A variety of other registration fees and taxes were also applicable. These included a registration fee for corporate charters (DESCA and DESBI) charged at a rate of between 0.25 percent and 2 percent, according to the firm's level of capital; and a proportional tax on income from securities (Taxe proportionnelle sur les revenues de capitaux mobiliers, TPRCM) for corporations paying dividends or fees to associates and shareholders. Residents were charged 16.5 percent and non-residents 25 percent. Other taxes included duties on property leases, labor housing rental, stamp duties, advertising fees, together with tax licences on land, mining and forests. 13 This section is based on World Bank (1992, 1995) and Gauthier and Gersovitz (1997) 4 The ICAI was a cascading tax, since it was imposed on the value of the good or service at each level of the production process, and not only on the value-added. This cascading effect meant that production tax increased with the number of intermediaries. 15 Businesses in their first two years of operation were exempt from the IMF (600,000 CFAF) and 1 percent tax although they had to pay the BIC. During years 3 and 4, their IMF and 1 percent tax obligations were reduced by half. 31 e) Finally, Cameroon corporations were ;ubject to taxes on insurance contracts, trade union income tax, an apprenticeship tax and various community taxes. Producers subject to full taxation wvho engaged in international trade faced the following additional fiscal obligations: a) Imports of intermediate goods were subject to four taxes, the first three dictated by UDEAC norms, and the fourth created by Cam -roon. The Droits de Douanes (DD) was applied at rates varying from 5 percent to 30 percent on all products, regardless of origin. The Droits d'Entrie (DE) also applied to all products and origins, with rates varying between 5 percent and 90 percent, although certain goods were exempt. The Taxe sur le chiffre d'affaires a l'importation (TCAI) was imposed at a rate of 10 percent of the CFAF value plus DD+DE. Finally, the Taxe complementaire a 1', mportation (TC) was charged ad valorem, with rates varying between 0 and 100 percent. b) Imports were also subject to other taxes, including an unloading fee, a municipal tax, a tax imposed by the Conseil national des chargeurs, a tax on meat inspection, a veterinary tax, and a special tax on fuel. Special treatment from the tax au;horities was available to manufacturers through a variety of mechanisms, on a case-by-case basis. These included: a) Tax unique (TU) Originally designed as a means of encouraging industrialization and trade between UDEAC countries, the TU offered firms several advantages. Qualifying firms were exempt from the domestic sales tax ([CAI), which was replaced by a firm-specific TU rate. The TU rate also replaced the tariff system. Furthermore, the TU granted preferential access to export markets in other UDEAC countries, since products were exempt from duties. Finally, neither the ICAI nor the TU tax were collected on sales to other firms with TU status. TU rates were negotiated on a firm-specific basis, and different firms may thus have paid different rates for the same product. [n addition, the same firm would pay different rates on its products, depending on the country to which they were exported. To obtain TU status, firms applied to the Management Commiiv.ee of the UDEAC Secretariat. b) Taxe Interieure a la Production (TIP') Since access to the TU proved difficult, Cameroon created a domestically-administered variant. This special regime also provided sales tax and tariff advantages, but in contrast to the TU, it did not give preferential access to the UDEAC market. Benefits and rates were negotiated with the Cameroon Ministry of Finance instead of with UDEAC. c) Investment Code. Major tax conces 3ions were also available under the Investment Code (IC). The IC was augmented in 1990 with the help of FIAS and USAID, and provided tax 32 exemptions and reductions for firms meeting the Code criteria. Five different schemes existed: the basic regime, the small and medium-sized enterprise regime, the strategic enterprise regime, the reinvestment regime and the free trade zone regime (see below)."6 In contrast to the TU/TIP rates, which could be negotiated with the authorities, IC benefits were supposedly non-negotiable. However, benefits under the TU/TIP and IC regimes were not mutually exclusive. Thus a firm could benefit under more than one scheme at once. d) Zone Franc and Point Franc Free trade zones (FTZ) were part of the Investment Code in 1990, but were covered by separate legislation and administered by a separate organization. To be eligible for a FTZ, a firm had to export 80 percent of its output and its activities had to be eligible for the basic Investment Code regime. The firm itself had to be located in an industrial free zone or be designated "Point franc industriel" (factory-specific free zone) if it needed to be adjacent to raw material. Free trade status brought full exemption from international and indirect taxes, and profit taxes were imposed at a reduced rate. e) Convention Speciale (CS) Firms that did not find special tax schemes suited to their own specific needs could negotiate directly with the Ministry of Finance to establish a Convention speciale (special agreement). No guidelines existed regarding the benefits and exemptions available under such agreements, and in theory a firm could have obtained full exemption from all tax obligations, including the Patente, for its lifetime. This unusual tax scheme was generally reserved for public or very large enterprises. The Fiscal Environment After 1994 Decrees were adopted in Cameroon on January 24, 1994, to implement the fiscal and trade reforms. These reforms included four components affecting external trade: a) Tarif exterieur commun (TEC) The four-types of tariffs were replaced by a unified single system known as the TEC, applicable to imports from non-UDEAC countries. Also, all external trade privileges under the Investment Code and special production regimes (TU, TIP, Conventions d'etablissement) were eliminated. b) Imports were classified into four categories, with tariff rates ranging from 5 percent to 30 percent, compared with rates ranging from 0 percent to 500 percent under the previous system. 16 For more details on the eligibility criteria and the benefits associated with each regime, see RPED (1993a), Table 5, Appendix C. 33 c) Tarifpreferentiel generalise (TPG) A general preferential tariff was introduced for trade between UDEAC countries, with an initial rate fixed at 20 percent of the applicable TEC."' d) A mechanism was created for charging a temporary surtax of not more than 30 percent on a set of products previously covered by q[uantitative restrictions and a list of designated products. With respect to indirect taxes, the ieform essentially replaced the various sales taxes with a value-added tax, and eliminated special privileges. The specific measures were: a) The elimination of all indirect tax privileges under the special production regimes (TU, TIP, Conventions d'etablissement) and the ::nvestment Code, except the Free Trade Zone. b) The introduction of a "Taxe sur le chil'fre d'affaire" (TCA) (sales tax), a quasi-VAT tax applicable to domestic production and to imported inputs and intermediates, replacing the former sales and production tax (ICA], TU, TIP). Three categories of products were specified: those subject to the normal rate (12.5 percent, increasing to 15 percent on January 1, 1995, and to 17 percent in 1996), those subjcct to the reduced rate (5 percent, increasing to 8 percent on January 1, 1995) and exempted goods.'8 c) The creation of a mechanism for appl ying excise taxes to certain products. On February 1, 1994, the reform went into force for firms governed by the common law system. Firms receiving special fiscal privileges were allowed a transition period. Those governed by the IC, TU and TIP were not subject to the new regime until the 1994-1995 fiscal year (beginning July 1, 1994). Firms governed by special agreements were given until December 31, 1995, to regularize their situation. TLis period of negotiation was later extended to March 31, 1996. 17 This rate was to be reduced to 10 percent on January 1 1996 and 0 percent on January 1 1998. 18 We use the term "quasi" because firms initially paid taxes on their purchases, then periodically applied to the government for reimbursement. 34 Notably, the reformns left the free trade zone (FTZ) intact. Hence, qualifying firms continue to enjoy full exemption from import duties and TCA, and are excused from income taxes in the first 10 ten years of their existence.'9 Also, exporters not in the FTZ can apply for refunds of a portion of the customs they pay on imported inputs. The fraction refundable is equal to the share of their total sales exported outside the UDEAC. 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