The Brazilian ``Tax War''

Abstract

This article tests for horizontal tax competition in the value-added tax (VAT) for a sample of Brazilian states in the period 1985-2001. The states have considerable autonomy over the VAT and often use it as an industrial policy tool. The empirical findings, based on the estimation of a tax reaction function in an error-correction setup, confirm that the states react strongly to changes in their neighbors' VAT code, especially those that belong to the same geoeconomic region. Also, there is a Stackelberg leader among the states, with the remaining jurisdictions responding strongly to its policy moves. There is no co-occupancy of tax bases among different levels of government and hence limited scope for vertical externalities in tax setting. But the fact that the federal government shares with the states part of the revenue of its more elastic taxes, such as the income tax, appears to affect the opportunity cost of horizontal tax competition.