A customs union results in the abolition of tariffs among the member nations while at the same time having a common tariff against the rest of the world. The formation of a customs union involves certain problems. Unless a satisfactory and agreed mechanism is evolved to overcome these problems, it cannot work in an efficient manner.
The main problems faced by a customs union are as follows:
1. Distribution of Custom Revenues:
When a customs union is formed and a common tariff is imposed, there is a crucial issue how the revenues collected from customs are to be distributed among the member countries.
Some of the alternatives in this connection may be:
(a) Each member country retains the amount collected at its own ports. In this case, countries will have gain or loss according to their geographical situation.
(b) Allocation of customs revenue can be made on the basis of place of consumption of imported goods and that of production of exported goods. This system may prove to be unjust in case the wholesale distribution of certain imports or processing of certain exports is concentrated in a specific member country.
(c) Customs revenues may be distributed on the basis of population or per capita incomes of the member countries. In this case, the controversy may arise on account of variations in the-values of imports and exports.
(d) Payments to smaller and land-locked member countries may be made on a lump-sum basis irrespective of the revenue receipts. Each one of these alternatives, has, no doubt, certain deficiencies and the member countries must arrive at some agreement through negotiations.
2. Loss of Revenues due to Inter-Member Trade:
Since the customs union involves removal of internal tariffs, the member countries suffer loss in custom revenues. Such a loss can be offset by creating a common pool and making payments of compensation to each member country in proportion to the quantum of loss.
3. Budgetary Problem:
The loss of revenue due to abolition of tariffs can create budgetary difficulties for some of the member countries. The revenue loss may be made good either through the imposition of some other taxes or from the revenue collections through higher tariffs against the non- member countries.
4. Administration of Customs:
The effective functioning of the customs union vitally depends upon the degree of efficiency of the administration of customs. Apart from infra-structural problems, the administration of customs may be undermined by the conflicting interests of the member countries and deliberate loose policing of borders.
In this connection, J. Viner has suggested alternative ways for administration of customs such as:
(a) Complete autonomy in administration of customs for the members,
(b) Joint supervision at the border posts,
(c) Complete assumption of responsibility of customs.
Jacob Viner emphasised that the efficient administration of customs required some degree of merger of customs administrative authority in the union.
5. Allocation of Cost of Custom Administration:
If there is joint administration of customs, the cost of administration has to be distributed among the members of the union. If each member country is autonomously administering its customs, there may not be sharing of costs. But when there is some degree of joint administration, some equitable basis for the distribution of costs must be evolved, with larger countries bearing a greater burden of cost of administration of customs and vice-versa.
6. Uniform Tariffs:
Since all the members are required to have a uniform tariff, some have to raise the rates of tariffs while others have to reduce them. All of them have to make highly complicated modifications. The changes in tariff rates for the purpose of uniformity can create serious internal economic dislocations apart from attracting severe criticism from the rest of the world.
7. Diversity in Tax Structure:
The differences in internal tax rates or possibilities of double taxation create serious hindrances in the free movement of labour and capital within the union. Some countries may be inclined to maintain a lower rate structure of taxes, while others may have higher tax rates. The member countries will have to go through highly- complex and detailed negotiations to tackle the problem of diversity in structure of taxes and have a common standardised tax structure.
8. Uneven Distribution of Gains:
The customs union often brings relatively larger gains to the advanced and the dominant member countries on account of free internal competition. Countries, having a higher structure of tariff rates, are likely to suffer from unemployment and balance of payments difficulties, subsequent to the abolition or reduction in tariff rates.
9. Internal Economic Dislocations:
After the formation of customs union, some industries that receive a greater degree of protection, reduce their productive capacity. On the opposite, certain other industries for which union, as a whole, has a greater comparative advantage have to enlarge their productive capacities. The reallocation of productive capacity results in losses in capital values of certain lands and urban sites.
Some other capital assets make large windfall gains. There is also a significant change in the pattern of demand for raw materials and other inputs. In fact, there are internal economic dislocations on wide scale. Unless readjustments are speedily made in the entire new structure, the customs union cannot operate successfully.
10. Adverse Effect on the Rest of the World:
The organisation of regional economic grouping naturally militates against the interests of non- member countries. The adverse effect on the latter can be off-set, if the common tariff structure is fixed at a level lower than that existing earlier. If the non-member countries remain adversely affected, they may shift their demand to some other countries offering them better terms of trade. Alternatively, they may organise themselves into rival regional economic groupings.
11. Fear of Political Domination:
There is real or imaginary fear among smaller member countries that the dominant countries can use them for serving their economic and political interests. There is some dilution of sovereignty, when the economic and political decisions are to be taken by a central administrative authority of the union.
It is only when the above problems or difficulties are satisfactorily resolved that the customs union can work efficiently and realise its objectives.