A computable general equilibrium analysis of the economic effects of the octroi

This study examines the economic effects of the octroi, a local indirect tax in Nepal. An economy-wide computable general equilibrium (CGE) model is developed to provide a framework for appraising the effects of the octroi on real economic variables. The CGE model is built around the framework of a social accounting matrix. The octroi is widely considered to be inefficient, inequitable, and prone to graft and corruption. Despite the general awareness of its undesirable effects, the continuance of the octroi is attributed to the inability to find equally lucrative sources of finance. The unilateral abolition of the octroi would cripple the tenuous finances of municipalities. This dissertation finds that the octroi imposes small but only adverse effects. With respect to aggregate results, as the octroi is eliminated, prices fall, increasing real current consumption and real GDP. With respect to the regional effects of the octroi, the study suggests that abolishing the octroi would result in increased rural-urban trade. A reduction in prices would raise real incomes which more than compensate for the drop in octroi revenue. Since the octroi prevents the integration of the rural region in the national economy, its elimination would improve the terms of trade of the rural regions significantly. An improvement in the terms of trade raises the demand for cheap rural labor, raising employment and incomes. The national economy as a whole would benefit because of the large benefits that would accrue to the rural regions which make up most of the country. All this indicates that the elimination of the octroi would result in favorable benefits to the Nepalese economy. While this study has strong claims to policy applicability, it has its shortcomings. Many assumptions are made in calibrating and running the models, and data problems further constrain the accuracy of the analysis. It is therefore important to emphasize the broad themes of results rather than draw direct policy conclusions.