Tax Reform and Network Effects

Abstract

This paper investigates the effects of a tax reform that eliminates tax rate heterogeneity and cumulative taxation using a general equilibrium model with multiple sectors with market power. Industries are connected through input-output linkages, and changes in taxation are not confined within industries. We calibrate the model to Brazil, a country with a highly distorted tax system. The revenue-neutral tax reform generates gains of 7.9% of GDP and 1.8% of welfare. Just eliminating VAT rate dispersion leads to a 6.0% increase in GDP. Due to propagation effects, in 10 sectors direct taxes increased but output and profits did not fall.